BCAJ | Bombay Chartered Accountant Journal

Section 10A of the Income tax Act, 1961 —Exemption to new undertaking in FTZ — (i) Whether receipt by way of reimbursement of expense eligible for exemption — Held : Yes

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Shangold India Ltd. vs. ITO

ITAT ‘E’ Bench, Mumbai.

Before D. K. Agarwal (J.M.) and D. Karunakara Rao (A.M.)

ITA Nos. 6041 & 6568/Mum./2002

A. Ys. 2003-04 & 2004-05. Decided on 6.5.2009

Counsel for assessee/Revenue : A. R. Shah/L. K. Agrawal

Section 10A of the Income tax Act, 1961 —Exemption to new
undertaking in FTZ —

(i) Whether receipt by way of reimbursement of expense
eligible for exemption — Held : Yes

(ii) Whether AO justified in denying the exemption in a
case where export proceeds received after 6 months but within the period of
one year — Held : No.
Section 2(24) r.w. Section 36 of the Income-tax Act, 1961 — Taxability of
delayed payment of employees’ contribution to ESIC — Held it is taxable as
business income and not under the head ‘Income from other sources’.

Per Karunakara Rao

Facts :

The issues before the Tribunal were as under :

1. The assessee was denied exemption u/s. 10A in respect
of Rs. 0.35 lac received from Export Promotion Council by way of
reimbursement of exhibition participation costs. The corresponding expense
was incurred by the assessee in the earlier year. According to the AO, the
receipt cannot be said to have been derived from export activity, hence the
claim for exemption u/s. 10A qua the said receipt was denied by him.
On appeal, the CIT(A) confirmed the AO’s order holding that the proximate
source of the receipt was the grant and was not the export proceeds.

2. Whether the delayed payments towards the employees’
contribution to ESIC u/s. 2(24) r.w. Section 36 were chargeable under the
head ‘Income from other sources’ as held by the AO or as business income as
claimed by the assessee.

3. The assessee was denied exemption u/s. 10A in respect
of the sum of Rs. 21.16 lacs since, the same was received beyond the
specified period of 6 months.

Held :

1. The Tribunal relied on the Delhi Tribunal decision in
the case of Perot System TSI Ltd. It noted that the said decision was in the
context of reimbursement by the EXIM bank. According to the Tribunal, the
decision had generated the legal principle viz., where the expenses
which were reimbursed had direct link with the business of the assessee’s
undertaking, the same were eligible for exemption u/s. 10A. Applying the
said proposition, the Tribunal held that the reimbursed amount received from
Export Promotion Council was directly linked to the business of the
assssee’s undertaking and therefore, entitled to deduction u/s. 10A.

2. The Tribunal agreed with the assessee’s reasoning that
when the contribution was made in time, such payments were allowed as
business expenditure, accordingly, the disallowance if any made in this
regard could only give rise to business income. Accordingly, it was held
that the delayed payments towards the employees’ contribution to ESIC was
taxable as business income.

3. The Tribunal noted that as per Section 10A(3) below
Explanation 1, the RBI was authorised to grant extension to the said period
of 6 months. Accordingly, relying on the Circular No. 28 of 30.3.2001 and
Circular No. 91 of 1.4.2003, the Tribunal agreed with the assessee that for
the unit in the SEZ, the RBI has granted extension period of one year.
Hence, it was held that the export proceeds realised within the extended
period were eligible for exemption u/s. 10A.

Case referred to :

Perot System TSI Ltd. (2007) (16 SOT 350) (Delhi).

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Nirav Shah

Income-tax Act, 1961 — Section 254 — Whether an order of the Tribunal can be recalled on the ground that it has been passed without considering decision cited in the course of hearing — Held : Yes.

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Jayendra P. Jhaveri vs. ITO

ITAT ‘B’ Bench, Mumbai.

Before M. A. Bakshi (VP) and Abraham P. George (AM)

MA No. 814/M/08 arising out of ITA No. 68/Mum/2004 and CO
166/Mum/07

A.Y. : Block Period 1.4.1989 to 14.9.1998.

Decided on : 2.4.2009.

Counsel for assessee/Revenue : Dharmesh Shah/R. S.
Srivastava

Income-tax Act, 1961 — Section 254 — Whether an order of
the Tribunal can be recalled on the ground that it has been passed without
considering decision cited in the course of hearing — Held : Yes.

Per Abraham P. George :

Facts :

The assessee had filed an appeal to the Tribunal against
the block assessment order passed in his case. The two issues raised by the
assessee and the direction of the Tribunal thereon were as under :

The first issue was that the notice issued u/s. 158BD gave
the assessee less than 15 days time to file the return and therefore was
invalid. For this proposition the assessee had relied on the decision of
Special Bench (SB) in the case of Manoj Aggarwal. The Tribunal decided this
issue against the assessee by relying on the decision of the Bombay High Court
in the case of Shirish Madhukar Dalvi, where it was held that technical
defects mentioned in a notice u/s. 158BC would stand cured by S. 292B. The
second issue was that a notice u/s. 143(2) was not issued and therefore the
assessment was invalid. For this proposition reliance was placed on twelve
decisions. The Tribunal in its order dealt with only one of the decisions
viz. decision of the Gauhati High Court in the case of Bandana Gogoi and
found it to be contrary to the decision of the Special Bench in Navalkishore &
Sons. It set aside the assessment and remitted it back to the AO for
completing it after observance of procedural law relating to issue of various
notices under the Act.

The assessee filed a miscellaneous application requesting
the Tribunal to recall its order on both the issues. On the first issue the
assessee submitted that the decision of SB in the case of Manoj Aggarwal had
made a distinction between the provisions of S. 158BC and S. 158BD and also
that the decision of the Bombay High Court in Shirish Madhukar Dalvi dealt
with S. 158BC. On the second issue the assessee submitted that the Tribunal
had not considered the other decisions relied upon by the assessee. According
to the assessee, non-consideration of the decisions cited constituted an error
apparent from record. For this proposition reliance was placed on the decision
of the Bombay High Court in the case of Stanlek Engineering Pvt. Ltd. The
assessee vide this miscellaneous application requested that the order passed
by the Tribunal be recalled.

Held :

On the first issue the Tribunal, after noting that there
was an amendment to the provisions of S. 158BD and that the present case was
for a period before amendment of S. 158BD, held that there was a mistake
apparent on record in not considering the correct position of law and the
decision of SB in Manoj Aggarwal’s case in the correct perspective. On the
second issue the Tribunal noted that it had considered only one of the
decisions relied on by the assessee. Following the ratio of the decision of
the Bombay High Court in the case of Stanlek Engineering it held there was an
apparent mistake in the order of the Tribunal. The Tribunal recalled its order
and directed hearing the appeal afresh.

Cases referred :

1 Stanlek Engineering Pvt. Ltd vs. CCE 229 ELT 61
(Bom)(2008).

2 Manoj Aggarwal vs. DCIT 113TTJ 377 (Del)(SB).

3 Shirish Madhukar Dalvi vs. DCIT 287 ITR 242 (Bom).

4 Bandana Gogoi vs. CIT 289 ITR 28 (Gau.)

5 Navalkishore & Sons Jeweller vs. DCIT 87 ITD 407
(Lucknow)(SB).

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Nirav Shah

Income-tax Act, 1961 — Section 2(22)(e) — Whether in a case where a shareholder holding more than 10% of the shareholding in a company in which public are not substantially interested is a debenture holder of such a company and also has current account wi

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Anil Kumar Agrawal vs. ITO, 14(2)(1)

ITAT ‘A-1’ Bench, Mumbai

Before R. K. Gupta (JM) and Abraham P. George (AM)

ITA No. 6481/Mum/2007

A.Y. : 2003-04. Decided on : April, 2009.

Counsel for assessee/Revenue : Madhusudhan Saraf & Rajiv
Khandelwal/R. S. Srivastava

Income-tax Act, 1961 — Section 2(22)(e) — Whether in a
case where a shareholder holding more than 10% of the shareholding in a
company in which public are not substantially interested is a debenture holder
of such a company and also has current account with such a company, while
considering whether such a shareholder has taken a loan or advance from the
said company aggregate of balance in debenture account and also current
account needs to be considered —Held : Yes. Whether share premium account
forms part of accumulated profits for the purpose of S. 2(22)(e) — Held : No.

Per Abraham P. George :

Facts :

The assessee was a shareholder of Star Synthetics Pvt. Ltd.
(SSPL) having more than 10% of its shareholding. The assessee had also
subscribed to 4% non-secured convertible debentures issued by SSPL of
Rs.50,00,000. The Board resolution which approved the issue of debentures
provided that a debenture holder could have a current account with the
company, provided that the debit balance in current account could not exceed
the amount of debentures subscribed by the debenture holder. The Assessing
Officer (AO) noted that the assessee had two accounts with SSPL — one in his
individual name and another in the name of his proprietory concern. The
aggregate amount of loans taken by the assessee and his proprietary concern
from SSPL was Rs.23,65,000. SSPL had reserves of Rs.64,28,793. The AO regarded
the aggregate of amounts borrowed by assessee and his proprietary concern as
deemed dividend u/s. 2(22)(e).

Aggrieved, the assessee preferred an appeal to the CIT(A)
where he submitted that the AO ought to have considered the balance in
debenture account alongwith the balance in the current account of the assessee
and his proprietary concern, and if so considered the assessee did not owe any
amount to SSPL. He also submitted that while considering the amount of
accumulated profits of SSPL, the balance of share premium should not be
considered as forming part of accumulated profits. The CIT(A) was of the
opinion that since debentures are for a fixed period and bear a fixed rate of
interest, their nature is different from that of an unsecured loan. He
confirmed the addition made by the AO.

Aggrieved, the assessee preferred an appeal to the
Tribunal.

Held :

The Tribunal after considering the meaning of the term
‘debenture’ as per various dictionaries and judicial precedents held that
debenture account is only a loan account and that while considering the amount
of loan taken by the assessee from SSPL the AO ought to have considered all
the three accounts viz. the debenture account, the assessee’s personal
account and the account of his proprietary concern and then concluded whether
the assessee has received any loan from SSPL.

Since upon consideration of the balance in all the three
accounts in aggregate the assessee did not owe any money to SSPL, the addition
made by AO and confirmed by CIT(A) was deleted by the Tribunal.

As regards inclusion of share premium in computation of
accumulated profits, the Tribunal found the issue to be covered in favour of
the assessee by the decision of the Delhi Tribunal in the case of Maipo India.

Cases referred :

1 DCIT vs. Maipo India Ltd., (116 TTJ 791)(Del.)

2 Narendra Kumar vs. UOI, (1960)(47 AIR 0430)(SC).

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Nirav Shah

S. 37(1) : Expenditure pertaining to earlier year period claimed by assessee in the year when demand for same received allowed

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(Full texts of the following Tribunal decisions are available
at the Society’s office on written request. For members desiring that the
Society mails a copy to them, Rs.30 per decision will be charged for
photocopying and postage.)

13 ITO v. Premier Automobiles Ltd.

ITAT ‘E’ Bench, Mumbai

Before K. C. Singhal (JM) and

Abraham P. George (AM)

ITA No. 2049/Mum./2005

A.Y. : 2001-02. Decided on : 17-1-2008

Counsel for revenue/assessee : S. C. Gupta/

Jayesh Dadia

S. 37(1) of the Income-tax Act, 1961 — Business expenditure —
Year of allowability — Expenditure pertaining to the earlier year period claimed
by the assessee in the year when demand for the same received — On the facts
expenditure claimed was allowed.

Per Singhal :

Facts :

During the year under consideration, the assessee had claimed
deduction of Rs.9.4 crore being compensation paid to Fiat India Pvt. Ltd. for
the use of the business premises and certain other facilities by the assessee
during the period from 1-0-1997 to 31-12-2000. According to the AO, the expense
related to earlier years, hence he disallowed the sum of Rs.8.78 crores,
allowing part of the expenditure which related to the year under appeal. On
appeal, the CIT(A) allowed the appeal of the assessee.

Held :

The Tribunal noted that the assessee had transferred its
entire premises to Fiat India, who in turn had allowed the assessee to use
certain portion of the premises as well as certain other services like supply of
power, water, etc. Under the agreement no consideration was fixed for the use of
these facilities. Thus, according to the Tribunal, it cannot be said that any
liability arose under the agreement and consequently, the assessee could not
make any provision in the earlier years. The liability arose only when Fiat
India decided to charge the assessee in respect of the said premises and the
facilities used by the assessee. Therefore, it was held that liability accrued
only in the year under consideration and accordingly, the order of the CIT(A)
was upheld.

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Nirav Shah

S. 30 : Expenditure on glass wall for better look of hotel is revenue expenditure

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12 Fition Hotel v. ITO

ITAT ‘E’ Bench, Mumbai

Before J. Sudhakar Reddy (AM) and

Sushma Chowla (JM)

ITA No. 7035/Mum./2003

Decided on : 8-3-2007

Counsel for assessee/revenue : K. Shivaram/

K. Kamakshi

S. 30 of the Income-tax Act, 1961 — Expenditure incurred on
construction of glass curtain wall for better look of hotel building — Whether
allowable as revenue expenditure — Held, Yes.

Per Sushma Chowla :

Facts :

The assessee was engaged in the business of running a hotel.
During the year under consideration it had spent a sum of Rs.7.06 lacs on
construction of glass curtain wall on the front side of the hotel, which was in
addition to the existing building wall. The assessee claimed that the entire
expenditure was revenue in nature which was incurred to improve the look of the
existing building and for trendy and better look to attract customers. According
to the AO, the work done was of enduring nature and held the same to be capital
in nature. On appeal, the CIT(A) observed that the expenses incurred by the
assessee resulted in creation of new assets, as it was an addition to the
existing hotel building.

Held :

According to the Tribunal, the glass curtain did not bring
into existence any new assets. The expenditure incurred was towards the
improvement of the look of the existing building which was about 20 years old.
The Tribunal further noted that the enhancement in the look of the building was
essential, as the assessee was in the business wherein customers are to be
attracted. Accordingly, the Tribunal held that there was no merit in holding
such expenditure as capital in nature and it allowed the expenditure claimed as
current repair.

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Nirav Shah

S. 2(24) : Amount received in consideration of right to telecast films in five years is taxable equally in five years

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11 Molly Boban v. ITO

ITAT Cochin Bench

Before N. Barathwaja Sankar (AM)

ITA No. 01 /Coch./2007

A.Y. : 2001-02. Decided on : 11-3-2008

Counsel for assessee/revenue : R. Sreenivasan/

T. R. Indira

S. 2(24) of the Income-tax Act, 1961 — Income — Year of
taxability — Amount received in consideration of right to telecast films for
five years — Whether assessee justified in claiming that the amount received is
taxable equally in each of the five years — Held, Yes.

Facts :

The assessee, an individual, was the world satellite telecast
right holder of certain feature films. In consideration for transfer of
exclusive rights to transmit, broadcast, etc. of four feature films to Asianet
for the period of five years, she was paid a sum of Rs.4 lacs. According to the
assessee, since the agreement was for the period of five years, the sum of Rs.4
lacs should be taxed over the said period of five years. However, the AO,
relying on the decision of the Apex Court in the case of Tuticorin Alkali
Chemicals & Fertilisers Ltd., brought to tax the entire sum of Rs.4 lacs in the
year under appeal. The CIT(A) on appeal upheld the order of the AO and held that
the income was in the nature of royalty.

Held :

The Tribunal accepted the contention of the assessee that she
had transferred/sold her rights in the said pictures for a period of five years,
which according to it, showed that the entire sum of Rs.4 lacs was the
consideration for the exercise of the rights by Asianet for a period of five
years. Accordingly, the Tribunal accepted the contention of the assessee that
the sum of Rs.4 lacs had to be assessed in five years and not in the year under
appeal alone.

Case referred to :

Tuticorin Alkali Chemicals & Fertilisers Ltd. v. CIT, 227
ITR 172 (SC)

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Nirav Shah

Two-Day Orientation Workshop specially designed for fresh Articled Students, 26th & 27th April 2013, at the M.C. Ghia Hall, Fort, Mumbai

Two-Day Orientation
Workshop specially designed for fresh Articled Students, 26th & 27th
April 2013, at the M.C. Ghia Hall, Fort, Mumbai

L to R – Mr. Bharatkumar Oza, Mr. Mayur Nayak, Ms. Nina Kapasi, Ms. Smita Acharya

In
this workshop organised by the Human Resources Committee, the following
learned faculties imparted learning to the articled students, on the
topics mentioned below:

In this workshop organised by the Human Resources Committee, the following learned faculties imparted learning to the articled students, on the topics mentioned below:

The workshop received a good response where newly enrolled articled students got a broad perspective of various subjects that they will handle during the course of their articleship.

Press Conference, 29th April 2013, at the Indian Merchants’ Chamber, Mumbai

A Press Conference was organised by the BCAS Foundation to discuss and explain the 97th Amendment to the Constitution of India dated 13th January 2012 wherein under Article 19, the term “Co-operative Societies” has been inserted. As per the legal opinion of Senior Advocate Firoze Andhyarujina released at this Press Conference, “After the Constitutional Amendment and the status granted to the co-operative societies of self-governance, the RTI Act would be applicable to the Co-operative Society, more particularly after it being self-governed by the Maharashtra State Ordinance of 2013, laying down the by-laws, rule, regulations, procedure and modalities”. However, as per the opinion of the former Central Information Commissioner Shailesh Gandhi, who was the chief guest at the occasion, the Right to Information Act would not be applicable to co-operative societies of any kind, including co-operative housing societies. Leading luminary Mr. Julio Rebeiro, and Mr. Narayan Varma, Trustee, BCAS Foundation, also discussed the implications of this amendment. The conclusion at the meeting was, that the applicability of RTI Act to co-operative societies would have to be tested by filing some RTI applications to housing societies, and pursuing the matter in appeal until it reaches the High Court.

mPower Summit, 10th & 11th May 2013, at the West End Hotel, Mumbai

The mPower Summit, held on 10th & 11th May, 2013 at the West End Hotel, Mumbai, was designed to help professional firms focus on “Mergers, Managing Growth and Mentoring Talent”.

The 2-day Summit, attended by over 50 participants, was unique in many ways – the speakers were drawn from 4 cities and the participants from 11 cities. Most of the participants represented the leadership team of their professional firms.

The keynote speaker, Ketan Dalal, connected well with the audience as he took them through his journey from a family firm to the leadership team of a Big-4. His talk was candid and inspiring as he not only opened up the windows of opportunities, but also cautioned on the hurdles along the way. His strongest message to the forum was that managing people is the key to a professional services firm, no matter what the size may be. In his charismatic and emphatic way, he concluded “remember, people leave people, people do not leave organisations….

When you see talent walking out of your door, introspect on how you are nurturing your human capital”.

The first day had interesting sessions. Sundeep Gupta, Chartered Accountant from Delhi explained the merger process, the science and art of engaging with another professional firm and the need to ensure a cultural match prior to merging. Sujal Shah, Chartered Accountant played the devil’s advocate and explored the possibility of separating out a niche practice when the firm is considering a merger. He presented the audience with the ecstasy of creating one’s own institution built on one’s values and belief system and nurturing a niche area as opposed to becoming a part of a large set up having multiple service lines.

The first day concluded with a session by the Committee Chairman Ameet Patel, Chartered Accountant who awakened the audience to the need for innovation in the professional services firm – he stressed on the need for providing innovative solutions for clients as also for the internal functioning of the firm. He smartly presented the pressing need for professional services firms to shift focus from delivery to discovery – from execution to innovation – from time based billing to value pricing.

The highlight of the Summit was the uplifting session by Padmashri T. N. Manoharan, Chartered Accountant where he spoke of the role of the senior partners in creating an institution. With anecdotes and real life examples, he touched the hearts of the audience as he explained that “we are all mortal individuals with the power to create lasting institutions”. His humility reflected in his participating in the entire 2-day Summit as a quiet observer and his leadership reflected in the values and vision that he rolled out in his talk.

The next session, by Nandita Parekh, Chartered Accountant, Convenor of the Committee and the co-architect of the Summit, spelt out the formula for “living happily ever after” post a professional merger. She emphasised the need for a Code of Conduct, succession plan for the leadership of the firm and strategy for nurturing and retaining talent. Her illustrated presentation drove home the points with ease, as also added some colour to the event.

The next session by Sagar Shah, Chartered Accountant from Pune, rolled out a strategy for growth through geographic spread and networking. Young and energetic, he showed the participants the wonders that can be achieved with a clear focus, with a well-defined strategy and with mastering technology. He shared the HR initiatives taken by his firm to ensure excellence, excitement and energy at all levels. A very interesting remark by him about how unimportant one’s own name was in the context of overall growth of one’s firm was an eye opener for the participants.

The last session, “Of the Participants, By the Participants, For the Participants” ably anchored by Ameet Patel, Chartered Accountant provided a grand finale to an Empowering Summit where each of the participants shared their key ‘take aways‘ from the Summit.

The mPower Summit, a third in the series of Power summits, has been successful in taking forward BCAS image as an innovator and as an organisation which addresses the need of its members even before they become a necessity. The vision of the committee in identifying the need and designing the Summit year after year has provided a legacy that needs to be continued. May the Power summit of the BCAS be the meeting place for future partners and the starting point for lasting relationships!

Half-day training workshop on Empathy, 16th April 2013, at the Navinbhai Thakkar Board Room, Vile Parle, Mumbai

The Human Resources Committee organised this workshop as a continuation of the leadership camp conducted earlier with the theme of “Living in Harmony”. The learned faculty Shri M. K. Ramanujam guided the participants on Empathy and discussed various connected issues such as Feeling, Emotions, Understanding and Empathising. The learned faculty also discussed Triggers of Anger and shared tips on Anger Management. The workshop received very good response and participants gained immensely from the wealth of knowledge and experience shared by the speakers.

Nirav Shah

Difficulties being Faced by Charitable Organisations on account of the first proviso of s.2(15)

29th March 2013
To
The Chairperson,
Central Board of Direct Taxes,
New Delhi.
Madam,
representation
Re: Difficulties being Faced by Charitable Organisations on account of the first proviso of s.2(15)

We wish to draw your attention to the harassment and difficulties being caused to genuine charitable organisations in Mumbai on account of the farfetched interpretation being adopted by assessing officers on the provisions of the first proviso to section 2(15).

Various charitable organisations running educational institutions and carrying on various other forms of charity, including relief of poverty, have been denied the exemption under section 11 by assessing officers, on the ground that the first proviso to section 2(15) applies to them. This is notwithstanding the fact that the CBDT has clarified vide its circular number 11 of 2008 dated 19.12.2008, that the first proviso to section 2(15) does not apply to the first 3 limbs of the definition of “charitable purpose” under section 2(15), and only applies to the last limb, advancement of any other object of general public utility.

We would like to draw your attention to the fact that this is likely to lead to substantial litigation, locking up of money intended for charitable purposes in payment of taxes pending disposal of appeals, resulting in the ultimate beneficiaries of such charities losing out on the benefits that they would otherwise have got from such charitable organisations. A significant impact is already being felt on the charitable activities being carried out, with many trusts having decided to scale down their activities, due to their funds being locked up in tax litigation.

In fact, earlier also, the definition of “charitable purpose” included the words “not involving the carrying on of any activity for profit” from 1961 till 1983. At that time as well, there had been substantial litigation on this aspect, including various decisions of the Supreme Court and many high courts. It was with the purpose of putting an end to this litigation that these words were omitted by the Finance Act, 1983 with effect from 1st April 1984. Reintroducing such provisions in the form of the first proviso to section 2(15) has again revived this litigation, which surely cannot be the intention behind this amendment.

It is submitted that the business carried on by a charitable trust could be of 3 kinds –
(a) where the business itself is the main object of the trust,
(b) where the business is incidental to the attainment of the objects of the trust, and
(c) where the business is in no way connected to the objects of the trust, but is a property held upon trust.

In businesses of type (a) above, if carrying on of the business itself is the main object, the trust would not be regarded as charitable, as held by the Supreme Court in the case of Sole Trustee, Loka Shikshana Trust 101 ITR 234, as the charitable purpose itself would be merely a sham. This was the position even prior to the insertion of the first proviso to section 2(15).

In businesses of type (b) above, the provisions of section 11(4A) would apply, and the trust was entitled to exemption of such income if separate books of accounts were maintained, prior to the insertion of the first proviso to section 2(15). This position continues for trusts engaged in activities other than that of the advancement of any other object of general public utility, and it is only trusts engaged in this residuary object of advancement of any other object of general public utility, which should lose the benefit of exemption after the insertion of the first proviso to section 2(15).

In businesses of type (c) above, the provisions of section 11(4) read with section 11(4A) applied prior to the insertion of the first proviso to section 2(15). Even after the amendment, such businesses continue to enjoy the benefit of exemption where the objects of the trust are not those of advancement of any other object of general public utility.

The purpose of the amendment was to ensure that trusts do not carry on business in the garb of charity. However, the amendment made by insertion of the first proviso to section 2(15) is unfortunately being interpreted by assessing officers as a blanket prohibition on carrying on of businesses by all charitable trusts. Again, assessing officers are treating all types of activities as business, including activities of mere letting of premises, conduct of educational courses, etc. This results in denial of exemption to a large number of genuine charitable organisations, which certainly does not seem to have been the intention behind the amendment.

It is therefore strongly suggested that the following amendments be carried out:

1. Both the provisos to section 2(15) be deleted;

2. Section 11(4) be amended to provide that “property held under trust” shall not include a business undertaking so held; and

3. Section 11(4A) be amended by inserting a proviso to that subsection to the effect that a business shall not be regarded as incidental to the attainment of the objectives of the trust merely on account of the fact that the income from such business feeds the charitable purposes.

These amendments will ensure that in all cases where business carried on by a trust is unrelated to its objects, the business income would be subjected to tax, and the trust would not lose exemption in respect of its other income which is actually utilised for its charitable purposes. As mentioned earlier, where the main object itself is the carrying on of a business, in any case, the trust would not be entitled to exemption, as the object would not be regarded as charitable, in light of the Supreme Court decision in Loka Shikshana Trust.

This amendment will also ensure that genuine charitable trusts do not suffer the harassment of efforts to treat charitable activity carried on by such trusts as business activity, and will not be denied exemptions on that ground.

We trust you will make efforts to implement our suggestions at the earliest, so as to enable charitable trusts to focus on their charitable activities, rather than on tax litigation.

Thanking you,

Yours faithfully

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Nirav Shah

Coalgate – Hysteria over individual culpability at the expense of institutional change is futile

India is in thrall to sleaze. The executive is hostage to serial charges of corruption, enfeebling it. The judiciary feels encouraged to step outside the remit of determining what is lawful, to pronounce on policy. The legislature is dysfunctional, as the Opposition professes outrage and prevents both debate and lawmaking. Public focus is on the empirical specifics of particular scams, rarely on quick fixes, and never on systemic and institutional reform.

Take the coal scam. What precisely is the scam? Once a framework of state monopoly in coal mining is taken for granted, as also that monopoly’s incapacity to mine sufficient quantities to meet the demand, it makes sense to allow those who use coal as a vital input to have their own captive mines. In this framework, the sources of government revenue are royalty on the mined coal and taxes on the profits generated from the use of coal. These accrue, regardless of the identity of the captive miners. So, the malfeasance in allocating captive mines to cronies lies not so much in loss of revenue for the government as in some entities arguably more entitled to the mines losing them to those less deserving.

Two things make access to domestic coal scamworthy: state monopoly in coal leading to shortages and repressed pricing at a discount to imported coal. Remove these two features, and auction coal mines to whoever offers the highest lease rental/ royalty/revenue share, there would be no more coal scams. But such institutional remedies are not on anyone’s mind. The closest thing to a policy remedy on the agenda is auctioning captive mines, which is a flawed, suboptimal solution. Differential importance of coal in different industries calls for separate, industry-wise auctions of captive mines. Instead of holistic policy remedies, the entire debate is on fixing culpability at individual and political levels. Such arbitrary grant of mines and other patronage have been part and parcel of the default mode of funding politics in India â€” through the proceeds of corruption. The systemic solution is to institute complete transparency as to the source of every paisa collected and spent by politicians and political parties. This interests few.

And the few institutional reforms that are in vogue are horrendous. Take the demand to make the CBI autonomous of the government, implicit in the criticism of the agency sharing its draft status report on coal allocation with officials in the Prime Minister’s Office, the coal ministry and the law minister. Can the CBI get clarity on intricate policy details without interacting with the concerned officials? And what is wrong if its report is vetted for accuracy by the same officials who have been helping the CBI formulate its report, before submission to the court? Will not any attempt to manipulate the findings be exposed before the courts? The only guarantee against police/investigative agencies going rogue is multiple lines of accountability to different institutions, the government, the courts, a committee of Parliament and the human rights watchdog.

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Nirav Shah

Freeing the parrot – Govt cannot brazen out Supreme Court’s observations

The Supreme Court’s observations on the Central Bureau of Investigation’s affidavit regarding alterations made to the status report on its investigation into coal-block allocations were not as specific and stringent as they could have been. The Court chose not to view it directly as contempt the way it had seen it in a 1997 case on hawala transactions, where the apex court had demanded that the CBI not share information with those who could be an accused in the case. But the broad tenor of the Court’s observations yesterday was to highlight how the “heart of the CBI report was changed on the suggestions of government officials”. There were thus sharp questions on why the CBI should be sharing its findings with those it might be investigating. The court did not entirely spare the law minister Ashwani Kumar either, questioning if the law minister asking to see the report was legally permissible. It appears the Court holds the CBI primarily responsible for allowing its independence to be called into question, and repeating what the government wishes it to say – memorably comparing the agency to a “caged parrot”. However, the tongue-lashing that the SC gave the CBI and the government’s law officers – who have been caught in flagrantly misleading the Court – should warn the government that this is not a crisis it can afford to ignore. The resignations of Mr Kumar and of the Attorney General are to be expected. The government cannot brazen it out for much longer.

The Court also addressed itself to the central question of the CBI’s investigation, making explicit a threat that it had earlier made implicitly – that if the government does not legislate proper independence for the CBI, the SC will step in and do something. This is a warning that the government cannot afford to overlook. There would be legitimate concerns about an unaccountable super-cop, but the situation is such that the government must work post-haste on legislative safeguards for the CBI against political interference. Naturally, controls for the CBI will have to be worked in to any solution, but it is clear that the current system is not working and that the SC’s patience, like that of the public, is at an end. The SC on this occasion chose to drag former CBI DIG Ravi Kant Mishra back from the Intelligence Bureau to head the investigation into coal-block allocations.

Politically, the Court’s strictures could not have been worse; the SC has found impropriety in the actions of both the law minister and of the bureaucrats of the coal ministry and the prime minister’s office. Before the SC spoke, the prime minister said in Parliament that he was “seized of the issue” and that “action would be taken”. That action should include a clear accounting of guilt, as well as the dismissal of the law minister and the Attorney General. And, finally, a draft for statutory independence of the CBI must be prepared.

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Nirav Shah

Vested interest has a say in India’s policy making: Shell

India is a growing economy, but vested interests have a play in India’s policy making, says the Netherlands-based energy giant Royal Dutch Shell Plc Jeremy B Bentham, vice-president, global business environment, Shell, said such interests were “a force in one direction”.

Citing Paul Krugman’s three ‘I’s—ignorance, interests and ideology — that do not let things happen when they should rationally be happening, Bentham said he had added two more to these —institutional inadequacy and inertia. According to him, all five factors were present in India.z

Bentham’s comments come at a time when India’s energy sector is mired in controversies around pricing and contractual and allocation issues.

“As a business, we cannot do with an energy ministry. We have issues fragmented across different departments, each of which has its different agenda, which is not very well joined up here,” he told Business Standard in an interview.

The presence of such elements brings up the question whether “transitional changes are trapped and is there a room to maneuver”. Bentham later presented to an industry audience the ‘New Shell Scenarios’, which looks at the trends in the economy, politics and energy as far ahead as 2100.

The first scenario, labelled “mountains”, sees a strong role for the government and introduction of firm and far-reaching policy measures. These help develop more compact cities and transform the global transport network. New policies unlock plentiful natural gas resources, making it the largest global energy source by the 2030s, and accelerate carbon capture and storage technology supporting a cleaner energy system.

The other scenario is of “oceans”, a more prosperous and volatile world. Energy demand surges due to strong economic growth. Power is more widely distributed and governments take longer to agree to major decisions. Market forces, rather than policies, shaped the energy system: oil and coal remain part of the energy mix but renewable energy also grows. By the 2070s, solar becomes the world’s largest energy source.

Bentham said India was developing more “oceancentric” and was growing economically. He said India needed to look more into developing of infrastructure to deal with the supply and demand issues in the energy sector.

“On supply, India is already a significant component in the global energy consumption and is going to be 10-15 per cent of global energy in the decades ahead. For that, you need to have infrastructure.”

That not only enables “supply investments”, but also ports and the railways participating in global economy. On the demand side also infrastructure questions are there. Important here is to develop cities in a planned way.

He indicated the country should look more into how it could participate in the energy scenario of South Asia and Asia Pacific. “It has to look into how to take advantage of the developments in global shale gas? Not only necessarily in encouraging production here, but also opening up opportunities globally,” he added.

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Nirav Shah

Scope of Revision of orders by the Commissioner u/s.263

Issue for consideration

Section 263 of the Income-tax Act, 1961 (‘the Act’) corresponding to section 33B of the Income-tax Act, 1922 (‘the 1922 Act’) was inserted in the statute with the main objective of arming the Commissioner of Income-tax (‘CIT’) with the powers of revising any order of the Assessing Officer (‘AO’), where the order is erroneous and resulted in prejudice to the interest of the Revenue. Prior to the introduction of section 33B in the 1922 Act, the Department had no right of appeal against any order passed by the AO and therefore, it was necessary to provide the CIT with the powers of revision.

While the power is not meant to be a substitute for the power of the AO to make assessment, the same can certainly be exercised when the order of the AO is erroneous and prejudicial to the interest of the Revenue. Whether or not the order is erroneous and prejudicial to the interest of the Revenue has to be decided from case to case.

The relevant provisions of section 263 reads as under:

“263(1) The Commissioner may call for and examine the record of any proceeding under this Act, and if he considers that any order passed therein by the Assessing Officer is erroneous insofar as it is prejudicial to the interests of the Revenue, he may, after giving the assessee an opportunity of being heard and making or causing to made such inquiry as he deems necessary, pass such order thereon as the circumstances of the case justify, including an order enhancing or modifying the assessment, or cancelling the assessment and directing a fresh assessment . . . . .”

The controversy discussed here revolves around the scope of revisional power of the CIT — whether it extends to issues examined by the AO but not discussed in the assessment order.

The Karnataka High Court recently had an occasion to deal with this issue, wherein the Court held that an assessment order is erroneous and prejudicial to the interest of the Revenue, if the AO has not given any conclusion and finding on the ground of revision in the assessment order, thereby, justifying the exercise of powers of revision u/s.263. In deciding the issue, the Karnataka High Court dissented with the earlier findings of the Bombay and Delhi High Courts on the subject.

Gabriel India’s case

The issue under consideration first came up before the Bombay High Court in the case of CIT v. Gabriel India Ltd., (203 ITR 108). In that case, Gabriel had claimed deduction of a sum of Rs.99,326 as ‘Plant relayout expenses’ as being revenue in nature, being business expenditure on account of exercise of merging the two plants which necessarily called for relocation of the facilities as well as adapting the existing structure and other services necessary for the plant as a whole. The AO had accepted the explanation of Gabriel and allowed the deduction as claimed by it.

Upon completion of assessment, the CIT issued notice u/s.263 on the ground that there was an error in the order of the AO in allowing the deduction of the amount, as it was capital in nature. The CIT did not accept the contention of Gabriel that there was proper application of mind by the AO, before allowing the claim of expenditure as revenue in nature.

On appeal by Gabriel to the Tribunal, the Tribunal concluded that the action of the CIT was not in accordance with the provisions of section 263.

Being aggrieved by the order of the Tribunal, the Revenue appealed to the High Court. The High Court, after the considering the facts of the case and perusing the orders of lower authorities, opined that the power of suo moto revision u/s.263(1) was in the nature of supervisory jurisdiction and could be exercised only if the circumstances specified therein existed.

Two circumstances must exist to enable the CIT to exercise power of revision u/s.263:
— The order of AO must be erroneous; and
— By virtue of the order being erroneous, prejudice is caused to the interest of the Revenue.

The High Court held that if the AO acting in accordance with law makes certain assessment, it cannot be termed as erroneous by the CIT simply because according to him the order should have been written more elaborately. The section does not visualise a case of substitution of judgment of the CIT for that of the AO, who has passed the order, unless the decision is held to be erroneous.

The High Court further observed that the AO had exercised the quasi-judicial power vested in him in accordance with law and arrived at a conclusion. Such a conclusion could not be termed as erroneous simply because the CIT did not feel satisfied with the conclusion. In such a case, in the opinion of the CIT, the order may be prejudicial to the interest of the Revenue, but it cannot be held to be erroneous for the exercise of revisional jurisdiction u/s.263. According to the Court, for an order to be erroneous, it must be an order which is not in accordance with the law or which has been passed by the AO without making any inquiry in undue haste. The Court noted that though the words ‘prejudicial to the interest of the Revenue’ have not been defined, but it must mean that the orders of assessment challenged are such as are not in accordance with law, in consequence whereof the lawful revenue due to the State has not been realised or cannot be realised. [Following Dawjee Dadabhoy & Co. v. S. P. Jain & Anr., (31 ITR 872) (Cal.) and Addl. CIT v. Mukur Corporation, (111 ITR 312) (Guj.)]

The High Court also observed that for re-examination and reconsideration of an order of assessment, which had already been concluded and controversy about which had been set at rest, to be set again in motion, must be subject to some record available with the CIT and should not be based on the whims and caprice of the revising authority. The High Court made the following specific observations as regards the issue under consideration to uphold the contention of the Tribunal, which is as under: “The ITO in this case had made enquiries in regard to the nature of expenditure incurred by the assessee. The assessee had given detailed explanation in that regard by a letter in writing . . . . . Such a decision of the ITO cannot be held to be ‘erroneous’ simply because in his order he did not make elaborate discussions in that regard . . . . . Moreover, in the instant case, the CIT himself, even after initiating proceedings for revision and hearing the assessee, could not say that the allowance of the claim of the assessee was erroneous . . . . . He simply asked the AO to re-examine the matter. That in our opinion is not permissible.”

Ashish Rajpal case

The issue under consideration had also come up before the Delhi High Court in the case of CIT v. Ashish Rajpal, (320 ITR 674). In that case, in the course of scrutiny, several communications were addressed by the assessee to the AO, whereby the information, details and documents sought for, were adverted to and filed, which were subject to grounds of revision u/s.263. On challenge before the Tribunal by the assessee of the powers of revision of the CIT, the Tribunal held that the assessee had filed all the relevant details and there was due application of mind by the AO on the grounds of revision. Therefore, merely because the assessment order did not refer to the queries raised during the course of the scrutiny and the response of the assessee thereto, it could not be said that there was no enquiry and that the assessment was therefore erroneous and prejudicial to the interest of the Revenue.

On appeal by the Revenue before the High Court, similar conclusions were arrived at and the exercise of the revisional power of the CIT, on the ground that there was lack of proper verification by the AO, was found to be unsustainable. Further, the High Court, after considering the decisions on the subject, explained the meaning of the expression ‘erroneous’ and ‘prejudicial to the interest of the Revenue’ as under:

“…..(iii) An order is erroneous when it is contrary to law or proceeds on an incorrect assumption of facts or is in breach of principles of natural justice or is passed without application of mind, that is, is stereotyped, inasmuch as, the AO, accepts what is stated in the return of the assessee without making any enquiry called for in the circumstances of the case, that is, proceeds with ‘undue haste’. [See Gee Vee Enterprises v. ACIT, (99 ITR 375) (Del.)]

(iv) The expression ‘prejudicial to the interest of the Revenue’, while not to be confused with the loss of tax, will certainly include an erroneous order which results in a person not paying tax which is lawfully payable to the Revenue. [See Malabar Industrial Co. Ltd. (243 ITR 83)]”

Infosys Technologies’ case

The issue under consideration came up recently before the Karnataka High Court in the case of CIT v. Infosys Technologies Ltd., (341 ITR 293).

Infosys had claimed certain deductions for A.Y. 1995-96 and A.Y. 1996-97 towards its tax liability on account of tax deducted at source (‘TDS’) from payments received in respect of its business activities in Canada and Thailand. The aggregate tax relief as claimed as per Double Taxation Avoidance Agreement (‘DTAA’) under India-Canada tax treaty and India-Thailand tax treaty for A.Ys. 1995-96 and 1996-97 were Rs.18,12,897 and Rs.48,59,285, respectively. The AO, during the course of original assessment proceedings, after considering the submissions and records of Infosys duly allowed the tax relief as claimed by it under the respective treaties.

However, the CIT, on a consideration of non-speaking order of the AO on the aforesaid tax relief so allowed and in light of Article 23(2) of the India-Canada DTAA and Article 23(3) of the India-Thailand DTAA, was of the view that the order was erroneous and prejudicial to the interest of the Revenue. The CIT exercised his powers u/s.263 of the Act and remanded the matter to the file of the AO to ascertain the exact tax relief to which Infosys was entitled under respective tax treaties.

On appeal by Infosys before the Tribunal, the revisional orders of the CIT u/s.263 were set aside by the Tribunal vide a common order, on the ground that the orders passed by the AO were not shown as erroneous and prejudicial to the interest of the Revenue by the CIT.

The Revenue, aggrieved by the order of the Tribunal, appealed to the Karnataka High Court. After considering the arguments of the respective sides and perusing the orders of the lower authorities, the High Court accepted the fact that the CIT in his order does not anywhere explicitly show as to how the order of the AO is erroneous and prejudicial to the interest of the Revenue. The High Court held that the object of section 263 is to raise revenue for the state. The said provision is intended to plug leakage of revenue by erroneous orders passed by the lower authorities, whether by mistake or in ignorance or even by design.

Reference was made by the Karnataka High Court to the observations of the Supreme Court in the cases of Electro House (82 ITR 824) and Malabar Industrial Co. Ltd. v. CIT, (supra) to hold that since the AO had not disclosed the basis on which the tax reliefs were arrived at in the assessment order, which being important for determination of tax liability, there was definitely a possibility of the order being both erroneous and prejudicial. The ratios of the decisions of the Bombay High Court in the case of Gabriel India (supra) and the Delhi High Court in the case of Ashish Rajpal (supra) were referred to but were considered as not applicable to the facts and circumstances of the present case. The High Court held that the argument that the materials had been placed before the AO and therefore, the AO had applied his mind to the same could not be accepted to restrict the power of the CIT to revise the orders u/s.263.

Further, the following specific findings were made by the High Court as regards the issue under consideration to uphold the exercise of revisional power of the CIT u/s.263:

“We are of the clear opinion that there cannot be any dichotomy of this nature as every conclusion and finding by the assessing authority should be supported by reasons, however brief it may be, and in a situation where it is only a question of computation in accordance with the relevant articles of a DTAA and that should be clearly indicated in the order of the assessing authority, whether or not the assessee had given particulars or details of it. It is the duty of the assessing authority to do that and if the assessing authority has failed in that, more so in extending a tax relief to the assessee, the order definitely constitutes an order not merely erroneous but also prejudicial to the interest of the Revenue…….”

Further the AO, pursuant to the directions of the CIT u/s.263, had re-examined the tax reliefs, resulting in some reduction of tax relief to Infosys. On appeal by the assessee before the CIT(A) and further before the Tribunal, the Tribunal had set aside the fresh assessment on the ground that the revisional jurisdiction of the CIT u/s.263 had been set aside at that point in time and the appeal against such fresh assessment by Infosys was accordingly allowed with necessary tax reliefs. Aggrieved by this Tribunal order, the Revenue had appealed against this order to the High Court, which appeal was clubbed with the appeals against the orders u/s.263. The High Court, on taking cogni-zance of these facts, set aside the matters to the file of the Tribunal, for deciding the issue on merits and in accordance with law.

Observations

Recently, the Full Bench of the Gauhati High Court in the case of CIT v. Jawahar Bhattacharjee, (67 DTR 217), after extensively considering the legal decisions and precedents on the subject, explained the expression ‘erroneous’ assessment in context of section 263 is an ‘assessment made on wrong assumption of facts or on incorrect application of law or without due application of mind or without following the principles of natural justice.’ Though the decisions of the Bombay High Court in the case of Gabriel India Ltd. (supra) and the Delhi High Court in the case of Ashish Rajpal (supra) were not specifically referred to in the aforesaid decision, the ratio of these judgments were accepted by the Full Bench in the decision.

The Karnataka High Court in the case of Infosys Technologies Ltd. (supra) has held that the AO should record reasons for his conclusions and findings in the assessment order, irrespective of whether the issue has been accepted or not by the AO. In case the assessment order does not contain the reasons for his findings and conclusions, then it may be construed as an order which is erroneous and prejudicial to the interest of the Revenue, whereby the action of revision by the CIT shall be justified u/s.263.

This interpretation would subject the concluded assessments of the assessees to revision by the CIT for want of duty not performed by the AO in recording reasons for his findings and conclusions in his orders. In other words, the assessees may be penalised for want of non-performance of the duty by the AO. If one were to construe the provisions of section 263 in such a manner, then all settled issues which are concluded at the assessment stage after due application of mind by the AO, may also be subject to revision by the CIT. Such a construction of the expression ‘erroneous order and prejudicial to the interest of the Revenue’ by the Karnataka High Court is clearly in contradiction to the Full Bench of the Gauhati High Court and other High Courts as referred to above.

In addition to the above, the following decisions have also held that merely because the AO should have gone deeper into the matter or should have made more elaborate discussion could not be a ground for exercising power u/s.263:

CIT v. Development Credit Bank Ltd., (323 ITR 206) (Bom.);

CIT v. Hindustan Marketing and Advertising Co. Ltd., (341 ITR 180) (Del.);

CIT v. Ganpati Ram Bishnoi, (296 ITR 292) (Raj.);

CIT v. Unique Autofelts (P) Ltd., (30 DTR 231) (P&H);

Hari Iron Trading Co. v. CIT, (263 ITR 437) (P&H); and

CIT v. Goyal Private Family Specific Trust, (171 ITR 698) (All.).

Further, from the limited facts as understood from the order, the Karnataka High Court also failed to appreciate that the material as filed by Infosys during the course of assessment before the AO for the claim of tax relief was also available for consideration before the CIT. However, the CIT, instead of considering the materials on record and then reaching the necessary conclusions, chose to remand the matter to the file of the AO for re-examination without giving any reasons and findings for satisfaction as to how the tax relief so claimed by the assessee was erroneous and prejudicial to the interest of the Revenue. The CIT, in that case, seems to have relied on the text of the impugned Articles of the DTAAs to remand the matter to the file of the AO for re-examination, without taking cognizance of the material filed by the assessee before the AO for claim of tax reliefs or pointing out any specific defects in the application of the impugned articles. The CIT has also in his order seems to have neither opined, nor demonstrated how the conditions provided under the respective tax treaties were not fulfilled by the assessee or satisfied only for a particular amount out of the total tax relief claimed. Under similar circumstances on different issues, the Bombay High Court in the case of Gabriel India Ltd. (supra), after elaborate discussions as reproduced above, had set aside the revisional order of the CIT.

Though it may sound paradoxical, the Karnataka High Court while expecting the AO, being a quasi-judicial authority, to record the reasons and conclusions for the findings in the assessment order, it allowed the CIT, also a quasi-judicial authority, to exercise the revisional power, though the satisfaction and reasons were not recorded for holding the order of the AO as erroneous and prejudicial to the interest of the Revenue. The powers of revision had been exercised by the CIT merely on the ground of a doubt that the AO had not properly applied his mind in carrying out the procedural aspect of allowing the tax relief as per the impugned Articles under consideration and because the assessment order did not discuss the issue.

While one appreciates that the CIT u/s.263 is never required to come to a firm conclusion before exercising his powers of revision, it is equally true that the CIT being a quasi-judicial authority, is also required to satisfy himself and give reasons before invoking the powers of revision. This legal proposition is also approved in the following decisions rendered in the context of section 263:

CIT v. T. Narayana Pai, (98 ITR 422) (Kar.);

CIT v. Associated Food Products, (280 ITR 377) (MP);

CIT v. Jai Mewar Wine Contractors, (251 ITR 785) (Raj.);

CIT v. Duncan Brothers, (209 ITR 44) (Cal.) — an order of the CIT not bringing any cogent materials on record and based only on certain hypothesis is unsustainable;

CIT v. Kanda Rice Mills, (178 ITR 446) (P&H);

CIT v. Trustees, Anupam Charitable Trust, (167 ITR 129) (Raj.) — the error envisaged in this section is not one which depends on possibility or guesswork, it should be actually an error either of fact or of law; and

CIT v. R. K. Metal Works, (112 ITR 445) (P&H);

Without prejudice to the aforesaid discussions, it would be relevant to mention that in the case of Infosys Technologies (supra), the reference to the observations of the decisions of the Supreme Court in the case of Electro House (supra) and Malabar Industrial Co. Ltd. (supra) may not help the case for justification of exercise of revisional power by the CIT u/s.263. While the decision of the Apex Court in the case of Electro House (supra) dealt with the question of whether it is necessary to issue notice to the assessee before assuming jurisdiction u/s.33B of the 1922 Act (corresponding to section 263) vis-à-vis requirements of issue of notice u/s.34 of the 1922 Act (corresponding to section 148, section 149 and section 150), the decision of the Apex Court in the case of Malabar Industrial Co. Ltd. (supra) had a specific finding of fact that the AO had undertaken assessment in absence of any supporting material and without making any inquiry, which does not seem to be the case in Infosys Technologies matter (supra).

In light of the above, the findings of the Karnataka High Court in the case of Infosys Technologies Ltd. (supra) may require reconsideration. Otherwise, practically, considering the manner in which orders are passed by the AOs, wherein the reasons for the conclusions and findings are only spelt out with regard to the issues where the claims of the assessees are not accepted, such a view may give a free hand to the CIT to exercise powers of revision u/s.263 in almost all cases and revise all such settled assessments, which is unwarranted.

Further, judicial propriety and judicial discipline required that the case of Infosys Technologies Ltd. (supra) should have been referred to a Larger Bench of the Karnataka High Court, particularly considering that the same High Court in the case of T. Narayana Pai (supra) had decided otherwise regarding want of satisfaction and recording of a finding by the CIT in the context of section 263.

The view taken by the Bombay and Delhi High Courts, that revision cannot be resorted to in cases where the relevant information has been examined by the Assessing Officer, though not recorded in the assessment order, therefore seems to be the better view.

Nirav Shah

GAAR — are safeguards adequate?

It was not surprising that the Government did not wait for introducing the General Anti Avoidance Rules (GAAR) as a part of the Direct Taxes Code (DTC). Its introduction in the Finance Bill, 2012 was natural corollary to the Supreme Court decision in the Vodafone’s case. The Government has now deferred the implementation of GAAR for a year and has introduced few more safeguards after negative reaction of the stock market and industry in general to GAAR.

Now, the discussion on the issue as to whether or not India should have GAAR has become irrelevant after its introduction in the Finance Bill. At this moment arguably, pertinent discussion could be about whether or not GAAR has enough safeguards that address the concerns of the taxpayers. Common concerns of the most taxpayers are that GAAR gives too much power to the tax authorities; it will also hit genuine tax planning schemes and it creates uncertainty as it cannot be predicted as to which arrangements will be hit by GAAR.

Many countries such as Australia, Canada, China, New Zealand, South Africa, and Spain among others have safeguards in varying degrees in their GAAR responding to the similar concerns expressed in their jurisdictions. This article discusses the safeguards in the Indian provisions and particularly, the safeguard provided by Australia, Canada, and UK on Panel akin to the Approving Panel in Indian GAAR.

Safeguards in the Indian GAAR GAAR has now the following safeguards after the amendments to the Finance Bill, 2012: The burden of application of GAAR rests with the tax authority.
Assessing Officer (AO) can invoke GAAR only after obtaining the approval of the Approving Panel.
The Approving Panel will have an ‘Independent Member’.
AO can pass Order only after the approval of the Commissioner.
Taxpayer can avail the facility of the Advance Ruling on GAAR.

The Government has also formed a committee for drafting and recommending the Rules and the Guidelines for the implementation of GAAR. The Guidelines are almost certain to specify a monetary threshold for invoking GAAR and may incorporate the Parliamentary Committee’s recommendation that the AO should record the reasons before applying GAAR.

Burden of proof is on the Department

The earlier version of GAAR had one of the most criticised provision under which the taxpayer was responsible for proving that the GAAR is not applicable to it. In the amended Bill, this particular provision is deleted to bring it in line with other tax charging provisions. Now, the burden of proving the applicability of the GAAR in a particular case rests with the tax authority.

Approving Panel

GAAR has provided one more safeguard in the form of the Approving Panel. The provision on the Approving Panel in the clause 144BA of the Finance Bill is as under:

The AO has to make a reference to the Commissioner for invoking GAAR.
The Commissioner shall provide an opportunity of being heard to the taxpayer on receipt of the reference. He shall refer the matter to the Approving Panel if he is not satisfied by the reply of the taxpayer and is of the opinion that GAAR provisions are required to be invoked. The Commissioner shall also decide as to whether the arrangement is an impermissible avoidance arrangement or not when the taxpayer does not object or reply.
The Approving Panel after providing an opportunity to be heard to the taxpayer has to dispose of the reference within six months after examining material and if necessary, after getting further inquiry conducted. The disposal could be either by declaring an arrangement to be impermissible or by declaring it to be not impermissible.

The AO will determine the consequences of such declaration of an arrangement as ‘impermissible avoidance arrangement’.

Every direction of the Approving Panel shall be binding on the AO and the AO shall complete the proceedings in accordance with the directions only after the approval of the Commissioner.
The period taken by the proceedings before the Commissioner and the Approving Panel shall be excluded from the time limitation for the completion of assessment. l The Approving Panel shall comprise of minimum three members. Out of which, two members would be of the Income-tax Department of the rank of Commissioner or above and third ‘independent’ member would be from the Indian Legal Service not below the rank of Joint Secretary.
The Board may make rules for the procedure, for efficient working of the Panel and for expeditious disposal of references.

This proposed Section is largely based on the provision under UK’s draft law on GAAR2. For appreciating the issues involved in Approving Panel, it might be worthwhile to peruse the information on similar panels formed by Australia and Canada as well as proposed Panel of UK for the application of GAAR.

Role of the Approving Panel

Australia3 (GAAR Panel) and Canada4 (GAAR Committee) have non-statutory, advisory or consultative body to assist tax officers in administration of GAAR and to ensure consistency in approach in application of GAAR. In both the countries, although the Tax Officer finally decides as to whether or not to apply GAAR, he considers the advice given by the Panel before taking the decision. Similarly, UK’s proposed statutory Advisory Panel also shall give only its opinion as to whether there is reasonable ground for the application of GAAR5. The Indian Approving Panel neither is an advisory in nature, nor is mandated to assist the AO on the application of GAAR. Neither the clause 144BA elaborate, nor the ‘explanatory notes to the Finance Bill’ explain the role of the Approving Panel. This ambiguity can create different expectations among taxpayers as it has happened in the case of the ‘Dispute Resolution Panel’ (DRP).

Many taxpayers see the DRP as an adjudicating body on a dispute between the taxpayer and the Department. This expectation is because of the words ‘dispute resolution’ used for the Panel along with the lack of clarity on its role. On the other hand, many Departmental officers perceive DRP as an administrative safety mechanism to prevent inappropriate application of law against a taxpayer. Their justification is based on the argument that, the Law does not intend to have an appellate level between the AO and the Tribunal even before the order is passed. Moreover, DRP cannot be an adjudicating body, as it does not have necessary powers to function as an Appellate Court.

The role of the Approving Panel appears to be of an administrative in nature for ‘approving’ or ‘disapproving’ applicability of GAAR, a function similar to that of the Range head (Additional Commissioner) who approves some of the AO’s orders6. However, in absence of clarity, officers on the Panel may consider that it is their job to ensure successful invoking of GAAR in deserving cases. Therefore, they also may give directions to strengthen the case of the Department. On the other hand, the taxpayer would like to have a neutral body in which the panel should decide against the Department in weak cases rather than the Panel issuing directions to strengthen the Department’s case. Therefore, elaboration of the Panel’s role will help all in its functioning.

Aspect of consistency in the Panel’s approach is also of worth consideration. Australia and Canada ensure consistency in the Panel’s decisions by having a system under which reference is made only from a single point (head office) and by having centralised Panel in the country. In India also, initially only one Panel may be constituted to ensure consistency. Number of Panels can be gradually added with the increase in work. The need for consistency also requires that the Panel members should be appointed for a longer duration and should not be frequently changed. It might be a good idea to have the members dedicated only for the work of the Approving Panel or the DRP for ensuring consistency in its approach.

Composition of the Panel
The Parliamentary Standing Committee has recommended that the Departmental body should not review application of GAAR but an independent body should review it. The Committee has suggested that the Chief Commissioner should head the reviewing body and it should have two independent technical members. However, the Government has decided to form a Panel consisting of the senior Tax Officers and an Officer of Indian Legal Service as against the arguments for having non-Governmental independent members. Now the composition of the Panel appears to be more balanced than what was previously proposed, although taxpayers would have preferred to have non-Governmental independent member on the Approving Panel.

The Australian GAAR Panel consists of senior tax officers, businessmen and professional experts. The Panel is headed by a senior Tax Officer7. UK’s Advisory Panel is proposed to be to be chaired by an independent person and will have a tax officer and an independent member having experience in area relevant to the activity involved in the arrangement8. Whereas, the Canadian GAAR Committee consists of the representatives from the different departments of the Government such as Department of Legislative Policy, Tax Avoidance and Income-tax Rulings. The Committee also has lawyers and representatives from the Department of Finance of the Government.9

Presence of the non-governmental independent members on the Approving Panel gives more confidence to taxpayers in its decisions. Tax-payers perceive such a panel to be fair and unbiased. It also results in external review of the Departments’ work on GAAR and makes the Department some-what accountable to external systems.

However, having independent non-governmental member in the Committee raises different issues, such as such member’s eligibility criteria, transparency in selection process, tenure, etc. Having non-Governmental independent members on the Panel also raises the issue of protection of taxpayers’ confidentiality. Not many taxpayers would prefer their affairs becoming known to other professionals or businesspersons. Again, non-Governmental independent members have conflict of perception and occasionally may have conflict interest. Unlike in many developed taxation systems, it is doubtful as to how many independent members in India would take an adverse view of the arrangement devised by a fellow professional or a businessperson. Further, a non-Governmental independent member on a Panel also may lead to the issue of his accountability, especially when the Panel’s decision is not advisory but is binding on the tax authority under the present law. Moreover, eminent independent persons may not be easily available for the Approving Panel work due to pressure on their time. Constituting a Panel with eminent independent persons is easier said than done and therefore, a Panel consisting of independent members also may not solve the problem.

Powers and procedure of the Panel

Both, the Australian GAAR Panel and the Canadian GAAR Committee do not investigate or find facts or arbitrate disputed contentions. They advise on the basis of the facts referred by the tax officer and by the taxpayer. The Panel may suggest tax officer to make additional enquiries if the facts are disputed. As against this, Indian Panel is armed with more powers and it can direct the Commissioner to get necessary enquiries conducted as the Panel’s role is not advisory in its nature.

The Australian GAAR Panel may extend invitation to the taxpayer to make oral as well as concise written submission before it. The Canadian GAAR Committee does not afford taxpayer right to represent before it, but they may file written submissions before it. The taxpayers are not entitled to have copies of the reports and other submissions made by the authorities or experts in their case before the Committee. However, they will receive the copy of the Committee’s decision along with the reasons of the decision. The Australian Tax office releases the decision of the Panel in the form of either taxation ruling or in the form of the summarised decision on issue to be followed by the tax officers as the official tax office position on that issue.

Working of the Panel

The statistics of Australia and Canada show that these bodies have recommended application of GAAR in majority of the cases referred to it. In a period from 1st July 2007 to 30th June 2011, the Australian Panel advised application of GAAR in 64% of cases, called for further information in 17% of cases, whereas it decided not to apply GAAR only in 19% of the cases referred to it10. Whereas, as on 31st March 2011, the Canadian Committee approved application of GAAR in 73% cases referred from the date since GAAR was first introduced in Canada in 1988¹¹. Based on this statistics, one can expect similar trend in India on approval of GAAR references.

The statistics of the decisions of these Panels are available in public domain in Australia and in Canada. Australia also releases the decisions of the Panel in form of taxation rulings or in form of decisions to be followed as a precedent. UK’s draft law also proposes publication of a synopsis of each opinion (without revealing the identity of
taxpayer to protect confidentiality) and publication of regular digests of such opinions.¹² It might be good to release statistics of the decisions of the Approving Panel for transparency.¹³

Purposive interpretation of GAAR

One relevant issue, which is not a safeguard but requires consideration for ensuring effectiveness of GAAR is of having a legal provision on interpretation of GAAR.

The Indian Courts have largely applied the rule of literal construction to the interpretation of taxing statutes. This approach is based on the following two principles:

Legislation should be strictly interpreted on the basis of the words used and legislative purpose should not be presumed and

If the words of a provision are found to be ambiguous, the ambiguity should be resolved in favour of the taxpayer.

This approach creates problem when taxpayer pay lesser taxes by using a legal construction or transaction based on a gap or a loophole in law which will place him outside reach of the law.14 Therefore, the Courts of Australia, UK and Canada more often use purposive interpretation on provisions of tax avoidance as narrow interpretation of the legal provisions could result in injustice. Purposive interpretation of taxing statute seeks to interpret the provision according to the object, spirit, and purpose of the tax provision. This approach is sum marised in the case of the Pepper v. Hart, (1993) 1 All ER 42, HL(E) as under:

“The object of the Court in interpreting legislation is to give effect so far as the language permits to the intention of the Legislature….. Courts now adopt a purposive approach which seeks to give effect to the true purpose of legislation and are prepared to look at much extraneous material that bears upon the background against which the legislation was enacted.”

Purposive interpretation is also justified on the ground of fundamental principle of taxation statute, which seeks to treat similarly placed taxpayers similarly. In absence of purposive interpretation, arrangement of one taxpayer may be treated as tax avoidance, but similar arrangement of other taxpayer may not be treated as tax avoidance due to some minor insignificant difference. Therefore, Australia15 and New Zealand16 have enacted a specific legal provision to ensure that the provision is interpreted according to purpose and object of the statute. Other provision permits them to use extrinsic aids to overcome the problem of gathering the purpose and object of the law17.

Tax laws deal with the transactions taking place in changing economic circumstances. Tax avoidance schemes are carefully devised so that legal provision may not catch them. Purposive interpretation could be helpful on such occasions. Therefore, clarification in the proposed Guidelines may help in ensuring uniformity in the judicial approach on interpretation of the GAAR.

Conclusion

The Indian Approving Panel is statutory and non-advisory body and its directions are binding on the AO. It is sufficiently empowered to carry out its function effectively by getting further enquires conducted. The Indian Panel is the most powerful when compared to similar Panels in other jurisdictions. Therefore, legally, the Indian GAAR has the strongest safeguard on this ground among all.

However, industry’s apprehensions on GAAR may be arising out on implementation of such tax laws in India. It is a fact that many of these concerns are because of the huge trust deficit between the Department and taxpayers. Improving their relationships is an uphill task in a country which has massive tax evasion leading to various estimates of the size of parallel economy. For the Government, raising more revenue by plugging revenue loss taking place due to tax evasion schemes is a matter of high priority when less than 3% of its population bears the burden of paying taxes. Therefore, there is no going back from GAAR. Now, one can only hope that, GAAR and its procedure will gradually evolve for better with the feedback of the stakeholders.

1    The author is Commissioner of Income-tax. Views expressed in the article are entirely personal.

2    Section 14, ‘Illustrative draft GAAR’, ‘GAAR Study’, Report by Graham Aaronson, QC, at p-52

3    PS LA 2005/24, 13th December 2005, Australian Taxation Office.

4    William Innes, Patrick Boyle and Joel Nitikman, ‘The essential GAAR manual: Policies, principles and procedures’, CCH Canadian Ltd. (Toronto: 2006) pp- 1-296, at p-90.

5    Para 61, See note-2, at p-72

6    Search Assessment Orders, some of the penalty orders under Chapter-XXI.

7    Para 23, see note-3.

8    Para 66, see note-2, at p 73

9    See note-4, at p 90

10    Out of total 55 cases, GAAR application was advised in 35, declined in 10 and decision deferred for various reasons in 9. Source- GAAR Panel Report, NTLG Minutes, March 2008, September 2008, September 2009, March 2010, October 2010, March 2011 and September 2011, Australian Taxation Office, Australia website.

11    Lynch Paul, ‘GAAR Committee Update-March 31 2011’ Canadian Tax Adviser, May 24,2011, http://www.kpmg. com/Ca/en/IssuesAndInsights/ArticlesPublications/ CanadianTaxAdviser/CTA_Uploads/

12    Para 5.25, see note 2, at p 34.

13    “We are working on an easy and transparent mechanism to implement GAAR, but more specifics will be notified once the Finance Bill is passed,” Shri R. Gopalan, Secretary, Economic Affairs, 16th April 2010, moneycontrol.com

14    Vanistendael Frans, ‘Legal framework for taxation’, Tax Law Design and Drafting, Vol-1, (ed, Victor Thuronyi), International Monetary Fund (1996), Washington DC, at p 45.

15    Acts Interpretation Act, 1901, Australia. section 15AA — Regard to be had to purpose or object of the Act.
“(1) In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.”

16    Interpretation Act, 1999, Section 5(1) “The meaning of an enactment must be ascertained from its text and in the light of its purpose.”

17 Australia section 15AB of Acts Interpretation Act, 1991 and New Zealand section 5(1) and 5(2) of the Interpretation Act, 1999.

Nirav Shah

Colour of Money

At the time that he presented the budget, the
Finance Minister had promised a white paper on black money. He presented
the paper in the recently concluded budget session, one of the few
promises he has managed to keep. The paper was welcomed or criticised by
members of parliament depending upon which side of the political divide
they belonged to. I was amused by the title of the paper. As one
matures one realises that there is nothing spotlessly white or totally
black in life and there are only shades of grey. There was a great
temptation to comment on or analyse the white paper, but then I realised
that such an analysis, in the limited length of an editorial could have
been described by the same dress that the former finance minister used
to describe the white paper. I therefore decided to restrict myself to a
few observations and share my thoughts on a related topic.

The
paper describes money as white or black. Whatever the colour most of us
strive to possess it. Whether one likes it or not it is the driving
force, for individuals, families, and yes, nations as well. Recently I
read a book titled the “Ascent of money” by Niall Ferguson, British
historian. The book traces the financial history of the world. Money in
the form of currency as we know today is a creation not more than few
centuries old, but since its discovery it has pervaded human life. The
standard definition of money is that it is a medium of exchange. To
function optimally it has to be durable, fungible, portable and
reliable. Modern day money whether it is paper, plastic or electronic
has all these attributes except the last one; reliability. The book
quotes with approval Jacob Bronowoski who said that the ascent of money
has been essential to the ascent of man. Many would dispute the
correctness of that statement.

The singularly distinctive
quality of modern day money is its ability to be stored for any length
of time for future use and consumption. This may be the cause or at
least the catalyst for some of the problems that the world faces today.
To illustrate, in 2007, the year in which one of the worst financial
crisis that continues to plague the world commenced, the CEO of Goldman
Sachs received$ 73.7 million as remuneration. In the same year George
Soros, the veteran speculator made $ 2.9 billion. All this at a time
when more than 1 billion people around the world earned less than $ 1 a
day. In this scenario, is the development of money synonymous with the
development of the human race? It is a question that is difficult to
answer since financial scams and scandals occur frequently enough to
make money appear to be a cause of poverty rather than prosperity.

We
strive to give our next generation good health, the best education and
enhanced security. None of this can be bought with money. We teach our
children, ethics, morality and the innumerable sterling qualities that a
human being must possess but when the child steps out into the world
the singularly significant assessment parameter is the money he makes,
the money he would leave for his future generations. We make a
distinction between what we practice and what we preach and seek to
justify the same. We as professionals tell our students that there is a
great difference between theory and practice. There certainly is but
should that difference be as wide as white and black? While accepting
the exalted status that money has we must be conscious and make our
future generations aware of its most serious limitation that it is only a
medium. When society evaluates the financial health of a person, the
questions to be asked are “how” he earned money and thereafter “how
much”? The order should not be reversed.

Before readers mistake
this editorial for a philosophical discourse, let me make a few
observations on the white paper. The paper states that black money is
the result of two categories of activities. The first category is that
of crime, drug trade, terrorism and corruption. In the second category
which according to the paper is the more likely reason of generation of
black money is the intent to defraud the public exchequer. It is
difficult to agree to this categorisation. Undoubtedly hard core crime,
drug money and terrorism are social and political problems which give
rise to unaccounted money; they can be controlled or contained by an
intolerant attitude of the state and participation of all its
enforcement agencies. Corruption must fall into a different category.

The
real problem is the second category. We must decide whether we want to
equate avoidance with evasion. Those who avoid taxes remaining within
the corners of law cannot be treated as generators of black money. In a
majority of the cases it is post compliance harassment that forces
people to side step regulation. Archaic, multiple laws and regulation,
coupled with uncontrolled discretion and lack of accountability on the
part of the bureaucrats and politicians leads to corruption. There is
thus a vicious circle of evasion of statutory obligations, and enjoyment
of the largesses under the benevolent eye of the corrupt authorities.
In the first category, the “black” money generated by crime is
distributed, however inequitable the distribution. In the second the
proceeds of evasion of statutory dues and particularly corruption are
siphoned off. Often they are then laundered with the blessings of the
corrupt authorities.

In the first category the money generated,
will give rise to violence and will maim citizens and the country but
the second is like a deadly cancer that will cause total decay of the
moral fabric.

The white paper discusses various methods by which
to curb the menace of unaccounted money. In this regard the government
must consider three requirements essential to ensure success in its
endeavour. Firstly there must be total transparency in regard to
thinking of the government. If the authorities consider certain action
of business or industry as contrary to legislative intent it must make
this fact known expeditiously. Secondly it needs to integrate inter
agency and intra agency databases, before increasing reporting
requirements an aspect that the white paper recognises, but one hopes
there will be follow up action. Thirdly before introducing a measure
like NOC for real estate transactions which the white paper
contemplates, past experience must be analysed otherwise the measure
will have limited effect.

We need fair, simple laws fairly and
humanly administered. What worries the nation is not the fiscal deficit,
because that will hopefully be corrected, but the trust deficit. When a
representative of the government stands on the floor of the house and
makes a statement it should be treated with the sanctity that it
deserves. We all know that today “black” money dominates our economy.
The endeavour must be to see that the generation of black money reduces.
Along with deterrent punishment for violators there should be an
incentive for compliance. In any economy compartmentalisation of “black”
and “white” money is virtually impossible. It is also irrational to
believe that black money will disappear from the landscape. The attempt
must be to gradually change the proportion. The proportion is such that
today the economy is a chequered one. The proportion of black should
reduce so much that it becomes an adorable beauty spot on flawless
beauty!

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Nirav Shah

GIVING — LESSONS FROM LIFE

“Give now, that the seasons of giving may be yours and not your inheritors” — Kahlil Gibran

(1) His name is Dhairya, age about 7 months. I have not even seen him. But he is in my list of Gurus! His mother is a C.A. One morning she called me, and conveyed that they are opening a bank account for Dhairya; and that the first cheque to be issued from his account will be for charity! Dhairya has taught me that one is never too young to start giving! I learnt that one can start giving at any age. The mother also taught me how children should be given sansakaras.

(2) Her name is Naseema Hurzuk. They fondly call her Naseemadidi. She became a paraplegic when she was barely 17. She must be 61 years old now. In spite of the terrible tragedy, she courageously built up her own strength and decided to help other handicapped persons. Her organisation is called ‘Helpers of the Handicapped’. She has by now helped over 8000 persons. Her autobiography ‘NASEEMA — THE INCREDIBLE STORY’ brings tears in one’s eyes. What touched me most is that even when she was in that dire state, she started donating blood! I learnt from Naseemadidi, that one’s handicap is no handicap in helping others. One only needs courage and, of course, the grace of God.

(3) His name was Behramjibhai Irani. He died several years ago. A middle-aged Irani musician, who played mandolin in film orchestras. I walked into his house on 2nd floor in an old building at Grant Road uninvited. I wanted to learn to play mandolin from him. He was making his living by playing in film orchestras, and earning only 30/40 rupees per day as and when he was called to play. I went to him for a few years, but anytime I asked him for his fees, the answer was “Go out of the house and down the stairs! I am not teaching people for making money.” What was extraordinary about Behramjibhai was — he was totally blind. Here was a blind musician, making a living by playing in orchestras, but teaching me a young man from well-to-do family and several other students free of charge and refusing any fees.

I learnt from Behramjibhai that even a blind person can make you ‘see’ and give you a vision of life.

(4) His name is Pandubhai Maganbhai Mahala. He is an adivasi. He lives in a small village located far away in Dharampur, a backward area on Gujarat-Maharashtra border — on the bank of a river. A few persons from Sarvoday Parivar Mandal were dreaming of putting up a school there. The question was of getting resources for buying land. Pandubhai — a poor adivasi very graciously gave away his land! Despite being poor, giving came effortlessly to him! I learnt from Pandubhai that one need not have lot of money in order to give. One only needs richness of the heart.

I cannot help recalling an article called ‘Madhuri and Pushpa’ about two girls seven years of age. It is my favourite one, because it is written by Mahatma Gandhi, ‘The Collected Works of Mahatma Gandhi’ (Vol. 23 : 6 April 1921-July, 1921 pp.330-333) and also because Madhuri in this episode is my mother. It is a great example of how during our freedom struggle even children contributed wholeheartedly. This is also a reminder to the present generation as to how millions of selfless sacrifices of young and old, rich and poor, were given in the fight for our independence. Readers can view the article on:

http://www.gandhiserve.org/cwmg/VOL023. PDF > Article no. 152, pg. no. 330.

This article time and again reminds me that what my mother could do when she was only seven, I am unable to do at 77. At seven she virtually gave away all her wealth. I am reminded that giving has no limits.

“. . . . And there are those who give and know not pain in giving, nor do they seek joy, nor give with mindfulness of virtue;

They give as in yonder valley the myrtle breathes its fragrance into space.

Through the hands of such as these God speaks, and from behind their eyes He smiles upon the earth . . . .”

— Kahlil Gibran

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Nirav Shah

2013 (30) S.T.R. 176 (Tri- Del) Sharwan Kumar vs. Commissioner of Central Excise, Chandigarh-I.

Whether process of denting & painting done by job worker inside the factory of vehicle manufacturer would be taxable under “business auxiliary service”?

Facts:
The appellant was undertaking certain jobs within the factory of JCBL Ltd. which was manufacturing bus bodies falling under Chapter-8707 of the Central Excise Tariff. The revenue was of the view that, the above activity amounted to “production or processing of goods for, on behalf of the client” as specified under the definition of “Business Auxiliary Service” and service tax was payable. The contention of the appellant was that the appellant was doing the activity in the factory of the manufacturer of excisable goods and these activities being incidental and ancillary to manufacture was covered by the definition of manufacture and such processes are specifically defined to be ‘manufacture’ in Section Note 6 of Chapter XVII of the Central Excise Tariff Act (CETA). Alternatively, they were eligible for exemption from service tax on such activity under Notification 8/2005-ST dated 01-03-2005 which provides exemption to job-workers doing processes when the principal manufacturer pays excise duty on the goods so produced. In the present case, JCBL paid excise duty on the bus bodies.

Held:
The JCBL’s factory manufactured bus bodies. The process of denting and painting were essential for completion of manufacture of bus bodies and the Tribunal did not find any reason to hold that these processes cannot be considered to be part of manufacturing activity within the meaning of section 2(f) of the Central Excise Act, 1944. Tribunal observed that Note 6 of Chapter XVII of CETA, these processes were essential for transforming the semi finished bus body into a complete and finished article. So if the process done by the appellant alone was seen, then also the argument of Revenue fails. The respondents denied the claim of the appellant for exemption under Notification 8/2005-ST on the reasoning that the appellant did not produce any evidence of duty payment of goods manufactured by JCBL Ltd. which was also not acceptable as they did these jobs within the factory of JCBL who regularly submitted excise returns to the excise department which also administers service tax levy. In absence of department establishing anything to the contrary, the appellant could not be penalised. Appeal as such was allowed.

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Nirav Shah

2013 (30) STR 184 (Tri- Del) Kota Pensioners Hitkari Sahakari Samiti Ltd. vs. C.C.E. Jaipur-I.

Whether co-operative society formed by retired Central/State Government employees is a “Commercial Concern”?

Facts:
The Appellant is a co-operative society of retired Central/State Government servants. Jaipur Vidyut Vitaran Nigam Ltd. (JVVNL) authorised the Appellant to collect electricity bills raised on its consumers and for such services commission was paid to the Appellant. The Appellant was not paying any service tax on such commission received. Revenue’s view was that the service rendered by the Appellant to JVVNL was taxable as business auxiliary service. Whereas the Appellant was not registered and did not pay service tax, the demand was confirmed and penalties were also levied. The Appellant contended that, during the period prior to 01-05-2006 only services rendered by a “commercial concern” was taxable under entry 65(105)(zzb) and the co-operative society formed by retired military personnel cannot be considered as commercial concern. They also contended that it provided services to JVVNL and not to the customers on behalf of JVVNL. Therefore, the activity cannot be classified within the clause “any customer care service provided on behalf of the client” or under the clause “provision of service on behalf of client” and therefore the activity was not taxable under Business Auxiliary Service. The Revenue relied on the decision in the case of Punjab Ex-servicemen Corporation vs. UOI 2012 (25) S.T.R. 122 (P & H) wherein the Hon. Court held that a co-operative society of ex-servicemen run without any profit motive had to be considered a commercial concern for the purpose of levy of service tax under the Finance Act, 1994.

Held:
It was held that in view of the decision in the case of Punjab Ex-servicemen Corporation (supra), Appellant could not get out of the tax net on pleading that they were not a commercial concern. The services provided was covered by the expressions “any customer care service provided on behalf of the client” and also under the clause “provision of service on behalf of client” and hence taxable. However, in view of the earlier Tribunal decision which was in favour of the Appellant for some time, it held that the extended period was not invokable and penalties also were deleted.

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Nirav Shah

2013 (30) STR 31 (Tri- Bang) Commissioner of Central Excise, Guntur vs. Varun Motors.

Can sales office be registered as “Input Service Distributor”?

Facts:
The Respondent, an authorised distributor for ‘Bajaj’ two and three wheelers operated from Vijayawada for 19 zones in the District to undertake sales and servicing of the vehicles. The respondent registered themselves as “Input Service Distributor” (ISD) in respect of their office premises at Vijayawada. It was held that it being a sales office could not be treated as service provider and therefore could not be granted registration as ISD and revoked the registration. Consequent upon the revocation, a credit of Rs. 48,143/- distributed as service tax credit to one of the authorised service stations was denied and ordered to be recovered. Appeal to Commissioner (Appeals) was allowed and therefore revenue filed the present appeal.

Held:
The Tribunal observed that the definition of the “Input Service Distributor” as defined in Rule 2(m) of the CENVAT Credit Rules, 2004 reads: “Input Service Distributor” means an office of the manufacturer or producer of final products or provider of output service, which receives invoices issued under Rule 4A of the Service Tax Rules, 1994 towards purchases of input services and issues invoice, bill or, as the case may be, challan for the purpose of distributing the credit of service tax paid on the said services to such manufacturer or producer or provider, as the case may be.” The reading of the definition clearly indicates that it is to be an office of the manufacturer or producer of final products. The sales office of the respondent was also undisputedly an office of the assessee/ service provider and therefore, there should be no objection to the said premises being treated as premises of “ISD”. Rejecting the revenue’s appeal, the credit distributed by ‘ISD’ was also held as regular.

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Nirav Shah

S. 9(1)(vii), 40(a)(i), 195 — Payments made for purchase of Internet bandwidth and TDS — Not FTS, not subject to TDS

New Page 19 DCIT
v. M/s. Estel
Communications Pvt. Ltd. (Delhi ITAT) (Unreported)

S. 9(1)(vii), S. 40(a)(i), S. 195
of the Act

A.Y. : 2003-04. Dated : 10-3-2008

Issue :

Disallowance u/s.40(a)(i) of the Act for
non-deduction of tax u/s.195 of the Act from payments made for purchase of
internet bandwidth and TDS.

Facts :

The assessee-company had entered into a reseller
agreement with a non-resident company. In terms of the agreement, the
non-resident company was to provide various internet services on non-exclusive
basis to the assessee-company for resale of these services to the end-user
customers in the territory. The Internet services pertained to provisions of
bandwidth with certain minimum performance speed. The privity of contract was
between the assessee-company and the non-resident company and there was no
privity of contract between the non-resident company and the end-user customers.
In terms of the agreement, the assessee-company had made certain payments to the
non-resident company. While making the payments, the assessee-company had not
deducted any tax at source. According to the AO, the assessee-company was
required to deduct tax u/s.195 of the Act, but since it had not deducted the
tax, he disallowed such payments u/s.40(a)(i) of the Act.

In the assessee-company’s appeal before him, the
CIT(A) observed that the issue was identical to the decision in Wipro Ltd. v.
ITO, (2003) 80 TTJ 191 (Bang). In that case, the Bangalore Tribunal had held
that the agreement was for use of standard facility and standard services; the
payments were for utilisation of customer-based circuits; the payments were not
fees for technical services u/s.9(1)(vii) of the Act and were not subject to
deduction u/s.195 of the Act. The CIT(A) therefore held that the payments were
not subject to TDS u/s.195 of the Act and that the disallowance u/s.40(a)(i) of
the Act was not warranted.

The Department preferred an appal to the Tribunal
against the order of the CIT(A). The Tribunal referred to several clauses of the
reseller agreement and observed that the assessee-company was not paying any
fees for technical services but making payment for the purchase of internet
bandwidth. Even though sophisticated equipment was being used and though the
Internet connectivity was through satellite link, the assessee-company cannot be
said to be availing technical services. Further, the Tribunal also noted that in
the assessee-company’s case for A.Y. 2001-02, the Tribunal had considered
similar issue of disallowance and held in favour of the assessee.

Held

Following the order of
the Bangalore Tribunal in the aforementioned case, the Tribunal upheld the Order
of the CIT(A) and held that :

(i) The payment made
by the assessee-company was not towards rendering of any managerial, technical
or consultancy services, but was merely for use of Internet access facility
and accordingly, the payment was not subject to tax u/s.9(1)(vii) of the Act.

(ii) As such the
assessee-company was not required to deduct tax at source u/s.195 of the Act.

(iii) Since there was
no liability to deduct tax u/s.195 of the Act, the amount could not be
disallowed u/s.40(a)(i) of the Act.

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Nirav Shah

S. 195 — Reimbursement of expenses incurred by non-resident promoters outside India — Not subject to TDS.

New Page 18 Bangalore
International Airport Ltd. v.
ITO (2008) 6 DTR (Bang.) (Trib.) 15

S. 195 of the Act

A.Y. : 2006-07. Dated :
17-12-2007

Issue :

Whether reimbursement of expenses incurred by
non-resident promoters prior to their participation in joint venture company is
subject to tax deduction u/s.195 of the Act ?

Facts :

The assessee-company was a joint venture company
established for development of international airport at Bangalore, having equity
participation from certain non-resident companies, which were also the promoters
of the assessee. The non-resident promoters had incurred various expenses
towards technical and other consultations. These consultations were undertaken
outside India prior to the award of the contract to the non-resident promoters
and payments were also made by the non-resident promoters outside India. The
shareholders’ agreement pertaining to the assessee-company provided for
reimbursement of development cost to the promoters. In pursuance thereof, the
Board of Directors of the assessee-company passed a resolution to the effect
that “The offshore expenses shall be advanced by private promoters. All
expenses will be reimbursed and capitalised after financial close“. The
reimbursement of the expenses was to be limited to 50%. Accordingly, the
assessee-company reimbursed 50% of the expenses to the non-resident promoters.

In his order u/s.195 of
the Act, the AO had accepted the fact that the amount was being paid much after
the incurring of the expenses by the promoters. However, since the expenses
included element of technical services and since they were incurred after the
execution of shareholders agreement, he was of the opinion that tax should have
been deducted or should be deducted. In this context, the assessee-company
brought to the attention of the AO the decision in Hyder Consulting Ltd., In
re (1999) 236 ITR 640 (AAR) and also contending that reimbursement of
expenses in no way involves any element of profit and further since the expenses
were incurred by the non-resident in respect of services rendered by another
non-resident outside India, TDS provisions were not attracted. The AO, however,
did not accept this contention and concluded as follows and proceeded to compute
the tax to be withheld by the assessee-company.

(a) The foreign
shareholders of the applicant company had provided certain services to the
applicant company.

(b) The contention
that part of these services were obtained from other parties is of no
consequence.

(c) All these services
which are proposed to be paid for by the applicant company now, have been
utilised by the applicant company in India.

(d) All these services
called by the applicant as ‘consultancy services’ fall squarely within the
meaning of fees for technical services, as provided for in Article 12 of both
the relevant DTAAs as also the IT Act.

(e) Thus, the
consideration payable for such services is chargeable to tax, even if its
nomenclature is ‘reimbursement’, as the income is deemed to accrue or arise in
India.

(f) Hence, withholding
provisions of S. 195 are clearly invoked.

(g) The rate of
withholding tax is 10% as per the respective DTAAs, in view of the fact that
it is the rate beneficial to the payees.

(h) The above
conclusions, based on the facts and information as provided by the applicant,
are to be seen in the context of S. 195 of the IT Act. The provisions of S.
195 are necessarily summary and are only for the purpose of determining the
issue and quantum of withholding tax. It follows that the said tentative
conclusion is subject to the test of final determination at the stage of
assessment.

In appeal by the assessee-company, the CIT(A) noted
the agreement and arrangement between the share-holders and also the arguments
of the assessee-company. CIT(A) did not dispute assessee-company’s claim of it
being a case of reimbursement of expenses and also that the reimbursement was
only to the extent of 50% of the actual expenses. However, observing as follows,
he held that the AO was justified in his conclusions :

(i) The nature of
services are such as would be prima facie covered by the definition of
FTS in IT Act as well as respective DTAAs.

(ii) Adequate support
in respect of quantification of costs reimbursed has not been furnished by the
appellant.

In appeal before the Tribunal, the Tribunal noted that the expenses were incurred by the non-residents out of India in their capacity as promoters and at the relevant time, S. 5 or S. 9 was not applicable, since it was not a payment by a resident to a non-resident. The payment by the assessee-company to the non-resident promoters was a case of reimbursement of expenses incurred and such reimbursement was limited to 50%, which could not be equated to amount paid for technical services. As such it would not involve any profit element. The expenses were incurred to ascertain the feasibility and viability of the project for the promoters to decide whether to participate in the project. One of the bidders whose bid was not accepted had also incurred certain expenses, 50% of which were reimbursed and the Department had permitted such reimbursement without any TDS. The Tribunal noted that there was no difference between the bidder whose bid was not accepted and the bidder whose bid was accepted.

Held:

The Tribunal held that on facts and circumstances, the reimbursement of 50% of the expenses incurred by the non-resident promoters outside India did not attract provisions of S. 195(2) of the Act.

Nirav Shah

India-USA DTAA — Examination fee paid to US Company — Not taxable

New Page 17 KnoWerX Education (India) Private

Limited, In re
(AAR) (unreported)

Articles 1, 4, 5, 7 of India-USA DTAA;

Sections 4, 5, 9, 195 of the Act

Dated : 30-4-2008

Issues :

(i)
Examination fee
collected in India by resident on behalf of American professional
organisations and remitted to them outside India — Taxability thereof :

(a) in terms of
the Act; and

(b) in terms of
India-USA DTAA.

(ii)
Characterisation of the income mentioned in (i) above.

(iii)
TDS obligations of the resident
in respect of the income mentioned in (i) above

Facts :

The applicant was an Indian company which had
entered into agreement with an American entity for promotion of professional
certification programmes and examinations conducted by the American entity. It
was also in the process of entering into agreement with another American entity
for the same purpose. Under both the agreements, the applicant was to act as
their agent. The applicant would carry out promotional and marketing activities;
collect registration forms and fees from candidates in India desirous of
enrolling for the programmes/examinations; and remit the fees to the American
entities after deducting certain administration expenses and commission. The
American entities would conduct examinations either through the applicant or
through other entities in India; evaluate answer sheets; award certificates to
the candidates; forward these certificates to the applicant; and the applicant
would in turn distribute them to the candidates.

The AAR considered the
following questions :

1. (a) Whether
examination fees collected by the applicant in India on behalf of the
American entities and remitted to them were their ‘income’ liable to tax in
India ?

(b) If answer to (a)
is in affirmative, how should that income be classified — as business
income, royalty or fees for technical services ?

2. Whether the
applicant was required to deduct tax at source in respect of the remittances
and if so, at what rate ?

The AAR first examined the questions in light of S.
5 of the Act and observed that in terms of S. 5(2), income of a non-resident
includes income which accrues, arises or is received in India, or which is
deemed to accrue, arise or to be received in India, from any source in India. In
this context, the AAR referred to the Supreme Court’s decisions in CIT v.
Ahmedbhai Umarbhai and Co., (1950) 18 ITR 472 (SC), CIT v. Ashokbhai
Chimanbhai, (1965) 56 ITR 42 (SC) and Seth Pushalal Mansinghka (P) Ltd.
v. CIT, (1967) 66 ITR 159 (SC) and observed that while the income did not
accrue or arise, nor was it deemed to accrue or arise in India, it was received
in India as an agent of the American entities in India. It further observed that
the income was in the nature of business income. The applicant was receiving
income in India on behalf of the American entities as their agent. Hence, in
terms of S. 4 and S. 5 of the Act, the examination fee collected by the
applicant on behalf of the American entities would be taxable in India.

The AAR then considered the questions in light of
India-USA DTAA. The applicant had stated in his application that the American
entities were non-profit organisations, which were determined by American tax
authorities as ‘tax exempt organisations’. In response, the Department had
contended that since these were ‘tax exempt organisations’, they could not be
regarded as tax residents of the USA and consequently, provisions of India-USA
DTAA could not apply. For this purpose, the Department relied on the provisions
of Articles 1 and 4 of India-USA DTAA. The Department also contended that
partnerships, trusts, etc. were regarded as ‘transparent entities’ in the USA
and were not liable to pay tax there. In response, the applicant filed
additional documents and submissions to prove that the American entities were
corporations incorporated in the USA; were not ‘transparent entities’; were
liable to pay tax in the USA; but being in certain specified category, were
exempted from payment of tax. The AAR, therefore, held that they were tax
residents of the USA and provisions of India-USA DTAA would apply.

The Department also put forth the argument that the
applicant should be treated as PE in India of the American entities. After
examining the provisions of Articles 7 and 5 of India-USA DTAA, the AAR found
that the applicant did not conclude any contract on behalf of the American
entities and the admission of candidates for programme/examination was solely
done by them. Further, the applicant did not carry on any of the other
activities mentioned in Article 5 (such as storage of goods, etc.); on facts, it
could not be considered as dependent agent; it had liberty to have similar
relationship with others; it was not wholly or substantially dependent on the
American companies; it appeared to carry on promotion in the ordinary course of
its business; and it was not subject to any control of the American entities
with regard to the manner of carrying on it.

Nirav Shah

Co-operative society : Deduction u/s. 80P(2)(a)(i) of I. T. Act, 1961 : A. Y. 1995-96 : Society engaged in procuring raw silk and marketing to its members: Interest received from members for supplying materials on credit : Entitled to deduction.

New Page 1

Co-operative society : Deduction u/s. 80P(2)(a)(i) of I.
T. Act, 1961 : A. Y. 1995-96 : Society engaged in procuring raw silk and
marketing to its members: Interest received from members for supplying
materials on credit : Entitled to deduction.

[CIT vs. Tamil Nadu Co-operative Silk Producers Ltd.;
311 ITR 224 (Mad)].

The assessee was a cooperative society engaged in the
business of procuring raw silk and twisted silk and marketing it to its
members. The assessee received interest from its members in respect of
material supplied on credit. For the A. Y. 1995-96 the Assessing Officer
rejected the claim of the assessee that the interest so received from the
members is deductible u/s. 80P(2)(a)(i) of the Income-tax Act, 1961. The
Assessing Officer held that the activity of the society in procuring and
supplying raw silk and twisted silk on credit to its members could not be
considered as “carrying on the business of banking or providing credit
facilities within the meaning of section 80P(2)(a)(i)”. The Tribunal allowed
the assessee’s claim.

On appeal by the Revenue, the Madras High Court upheld the
decision of the Tribunal and held that the assessee co-operative society was
eligible for the benefit of section 80P(2)(a)(i) of the Act in respect of the
interest received from its members for supplying the materials on credit.

levitra

Nirav Shah

Salary — Perquisite — Stock option issued subject to conditions is not a ‘perquisite’ — Law amended by insertion of S. 17(2)(iii)(a) in the Act w.e.f. 1-4-2000 is not retrospective.

New Page 2

10 Salary — Perquisite — Stock option issued
subject to conditions is not a ‘perquisite’ — Law amended by insertion of S.
17(2)(iii)(a) in the Act w.e.f. 1-4-2000 is not retrospective.

[CIT v. Infosys Technologies Ltd., (2008) 297 ITR 167
(SC)]

The respondent-assessee, a public limited IT company based in
Bangalore, to implement the Employees’ Stock Option Scheme (‘the ESOP’), created
a trust known as Technologies Employees’ Welfare Trust and allotted 7,50,000
warrants at Re.1 each to the said trust. Each warrant entitled the holder
thereof to apply for and be allotted one equity share of the face value of Rs.10
each for a total consideration of Rs.100. The trust was to hold the warrant and
transfer the same to the employees of the company under the terms and conditions
of the scheme governing the ESOP. During the A.Ys. 1997-98, 1998-99 and
1999-2000, warrants were offered to the eligible employees at Re.1 each by the
Trust. They were issued to the employees based on their performance, security
and other criteria. Under the ESOP scheme, every warrant had to be retained for
a minimum period of one year. At the end of that period, the employee was
entitled to elect and obtain shares allotted to him on payment of the balance
Rs.99. The option could be excised at any time after 12 months, but before the
expiry of the period of five years. The allotted shares were subject to a
lock-in period. During the lock-in period, the custody of the shares remained
with the trust. The shares were non-transferable. The employee had to continue
to be in service for 5 years. If he resigned or if his services be terminated
for any reason, he lost his right under the scheme and the shares were to be
re-transferred to the trust for Rs.100 per share. Intimation was also given to
the BSE that 7,34,500 equity shares were non-transferable and would not
constitute good delivery. Till September 13, 1999, all the shares were stamped
with the remark ‘non-transferable’. Thus the said shares were incapable of being
converted into money during the lock-in period.

For the A.Y. 1999-2000, the Assessing Officer held that the
total amount paid by the employees, consequent to the exercise of option was
Rs.6.64 crores, whereas the market value of those shares was Rs.171 crores. He
held that the ‘perquisite value’ was the difference between the market value and
the price paid by the employees for exercise of the option. He, therefore,
treated Rs.165 crores as ‘perquisite value’ on which TDS was charged at 30%. It
was held that the respondent-assessee was a defaulter for not deducting TDS
u/s.192 amounting to Rs.49.52 crores on the above perquisites value Rs.165
crores. Similar orders were also passed by the Assessing Officer for the A.Y.s
1997-98 and 1998-99. These orders were confirmed by the Commissioner of
Income-tax (Appeals). No weightage was given by both the authorities to the
lock-in period. Both the authorities took into account the ‘perquisite value’ as
on the date of exercise of option. Aggrieved by the aforesaid decisions, the
respondent-assessee carried the matter in appeal to the Tribunal, which took the
view that the right granted to the employee for participating in the scheme was
not a ‘perquisite’ u/s.17(2)(iii) of the Act. This decision of the Tribunal
stood confirmed by the judgment delivered by the Karnataka High Court on
December 15, 2006. On civil appeals by the Department, the Supreme Court noted
that during the A.Ys. 1997-98, 1998-99 and 1999-2000, there was no provision in
the Act which made the benefit by way of ESOP taxable as income specifically. It
became specifically taxable only with effect from April 1, 2000, when S. 17(2)(iii)(a)
stood inserted. However, the issue before it was not with regards to the
taxability of the perquisite, but was with regards to the value of perquisite.
The Supreme Court held that a warrant is a right without an obligation to buy.
Therefore, a ‘perquisite’ cannot be said to accrue at the time when warrants
were granted. The same would be the position when options vested in the
employees after a lapse of 12 months, as it was open to the employees not to
avail of the benefit of option. It was open to the employees to resign and there
was no certainty that the option would be exercised. Further, the shares were
not transferable for a period of 5 years (lock-in-period). If an employee
resigned during the lock-in-period the shares had to be retransferred. During
the lock-in-period, possession of the shares remained with the trust. The shares
were not transferable and it was not open to hypothecate or pledge the said
shares during the lock-in-period. During the said period, the shares had no
realisable value, hence, there was no cash inflow to the employees on account of
mere exercise of options. On the date when the option was exercised, it was not
possible for the employees to foresee the future market value of the shares.
Therefore, the benefit, if any, which arose on the date when the option stood
exercised was only a notional benefit whose value was unascertainable. The
difference in the market value of shares on the date of exercise of option and
the total amount paid by the employees consequent upon exercise of the said
option therefore cannot be treated as perquisite. The Supreme Court further held
that S. 17(2)(iii)(a) inserted by the Finance Act, 1997 w.e.f. 1-4-2000 was not
clarificatory and retrospective in operation because till 1-4-2000, in the
absence of the definition of ‘cost’, the value of the option was
unascertainable. The Supreme Court held that the Department was not justified in
treating Rs.165 crores as the perquisite value for the A.Y.s 1997-98 to
1999-2000 and the assessee was not in default for not deducting tax thereon.

levitra

Nirav Shah

Export — Deduction u/s.80 HHC — Export profits in the business of growing, manufacturing and exporting of tea — Deduction u/s.80 HHC to be computed after apportionment, only against 40% of proportionate income

New Page 2

8 Export — Deduction u/s.80 HHC — Export
profits in the business of growing, manufacturing and exporting of tea —
Deduction u/s.80 HHC to be computed after apportionment, only against 40% of
proportionate income.

[CIT v. Williamson Financial Services & Ors., (2007)
297 ITR 17 (SC)]

Rule 8(1) of the Rules provides that 40% of the composite
income from sale of tea, grown and manufactured, arrived at on making of the
apportionment “shall be deemed to be income liable to tax”.

The assessee exported tea in the accounting year. They were
entitled to deduction u/s.80HHC, in respect of the export. They were in the
business of growing and manufacturing tea. Since they earned composite income,
their case stood covered by Rule 8(1). In the returns, the assessee claimed S.
80HHC deduction against the entire composite income before application of Rule
8(1). This working was rejected by the Assessing Officer who took the view that
the deduction u/s.80HHC can be allowed after the 60 : 40 apportionment as 40%
income was the gross total income. However, in appeal, the Commissioner of
Income-tax (Appeals) reversed the decision of the Assessing Officer by holding
that the Assessing Officer should have first granted the S. 80HHC deduction
against the entire tea income before applying Rule 8(1). Against the said
decision of the Commissioner of Income-tax (Appeals), the matter was carried in
appeal to the Tribunal who took the view that the Assessing Officer was right in
allowing S. 80HHC deduction only against part of the income from tea, which was
taxable under the 1961 Act, namely, 40% of the income. This view of the Tribunal
stood reversed by the High Court. On appeal, the Supreme Court held that
‘Agricultural income’ falls in the category of exempted income. It is neither
chargeable nor includible in the total income. On the other hand, deduction
under Chapter VI-A is for ‘income’ which forms part of total income but which is
tax-free. Rule 8(1) segregates agricultural income which is exempted income from
business income which is chargeable to tax. Therefore, to the extent of 40% only
the income is chargeable and computable. In this view of the matter, the
assessee cannot claim S. 80HHC(3)(c) deduction u/s.80HHC(3)(a) against the
entire tea composite income and can claim only against proportionate income.

Nirav Shah

Export — Deduction u/s.80HHC — Amendment made by the Finance (No. 2) Act, 1991, in S. 80HHC of the Income-tax Act, 1961, with effect from April 1, 1992, to the effect that for the purpose of the special deduction thereunder business profits will not inclu

New Page 2

9 Export — Deduction u/s.80HHC — Amendment
made by the Finance (No. 2) Act, 1991, in S. 80HHC of the Income-tax Act, 1961,
with effect from April 1, 1992, to the effect that for the purpose of the
special deduction thereunder business profits will not include receipts by way
of brokerage, commission, interest, service charges, etc., is only prospective
in nature.

[K. K. Doshi & Co. v. CIT, (2008) 297 ITR 38 (SC)]

The Bombay High Court in CIT v. K. K. Doshi & Co.,
(2000) 245 ITR 849 (Bom.) had held that amendment in law from the A.Y. 1992-93
that the business profits would not include receipts by way of brokerage,
commission, interest, rent charges or any other receipt of a similar nature was
clarificatory in nature and therefore retrospective in operation. On an appeal,
the Supreme Court following its decision in P. R. Prabhakar (2006) 284 ITR 548
(SC) held that the amendment in question was prospective in nature.

levitra

Nirav Shah

Charitable Trust — For claiming benefit u/s.11(1)(a), registration u/s.12A is a condition precedent.

New Page 2

7 Charitable Trust — For claiming benefit
u/s.11(1)(a), registration u/s.12A is a condition precedent.

[U.P. Forest Corporation & Anr. v. Dy. CIT, (2008) 297
ITR 1 (SC)]

The U.P. Forest Corporation, the appellant, was constituted
by a Notification issued u/s.3 of the U.P. Forest Corporation Act, 1974. In the
year 1977, the Income-tax authorities issued a notice to the corporation to file
its return of income for the A.Y. 1976-77. The corporation challenged the said
notice by filing writ petition which was disposed of by the High Court by
holding that the corporation was a local authority u/s.10(20) of the Act and was
entitled to claim exemption. Since the said order was not challenged by the
Revenue, the same became final and remained in force till a contrary view was
taken by the Supreme Court in respect of the A.Ys. 1977-78, 1980-81 and 1984-85
in the case of CIT v. U.P. Forest Corporation, reported in (1998) 230 ITR
945.

For the A.Y. 1977-78, the corporation’s income was assessed
by making some additions of income and deleting some deductions claimed in the
return of income. On an appeal being filed, the Commissioner (Appeals) upheld
that the corporation was exempt from paying tax, on the ground that it was a
‘local authority’ within the meaning of S. 10(20) of the Act. Insofar as the
relief sought regarding additions of income and deleting of deductions is
concerned, the Commissioner declined to decide the said issue. The Tribunal set
aside the said order of the Commissioner (Appeals) and held that the corporation
was not a ‘local authority’ and remanded the appeals to the Commissioner
(Appeals) for rehearing on the merits on the issue of grant of relief relating
to additions/deductions. Since the corporation was also assessed for the A.Y.
1984-85 as was assessed for the A.Y. 1977-78, the corporation preferred writ
petition before the High Court of Allahabad which was accepted, and the High
Court declared that the corporation was a ‘local authority’ and was entitled to
exemption u/s.10(20) of the Act. It was held that it was entitled to exemption
u/s.11(1)(a) of the Act being a charitable institution.

Aggrieved by the said order, the Department chose to file
special leave petition before the Supreme Court, wherein leave was granted and
ultimately the appeals were accepted and order passed by the High Court was set
aside. It was held that even though S. 3(3) of the U.P. Forest Corporation Act
regards the corporation as being a local authority for the purpose of the Act,
it would not, in law, make the corporation a local authority for the purpose of
S. 10(20) of the Act. On the question whether the corporation was to get itself
registered u/s.12A of the Act for invoking the provisions of S. 11(1)(a) of the
Act to claim exemption being a charitable institution, it was held that since
the question had not been raised before any of the authorities below, the High
Court should have remanded the case back to either the assessing authority or
the Tribunal for a decision. The Supreme Court, under the peculiar facts and
circumstances of the case, directed the assessing authority to consider the
claim of the appellant-corporation as to whether the appellant was not liable to
be taxed in view of the provisions of S. 11(1)(a) of the Act as a charitable
institution.

In the meantime, following the decision of the High Court in
W.P., the Commissioner (Appeals) allowed the appeals of the corporation in
respect of the A.Ys. 1977-78 and 1980-81 allowing exemption u/s.10(20) and S.
11(1)(a) of the Act.

The appellant-corporation, on July 11, 1988, moved an
application before the competent authority for being registered u/s.12A of the
Act, which was rejected after a gap of nine years on March 18, 1997.

Against the said rejection, the corporation filed writ
petition before the High Court during the pendency of which the corporation
filed another application for the purpose on May 4, 1998. The High Court allowed
the writ petition and set aside the order of the competent authority rejecting
the application of the corporation for registration, on the ground that the
Commissioner had passed an order in violation of the principles of natural
justice inasmuch as the appellant-corporation had not been given an opportunity
of hearing and directed the Commissioner to redecide the corporation’s
application for registration after giving an opportunity of hearing to the
corporation. The Commissioner decided against the corporation against which
order an appeal filed by the corporation before the Tribunal at Lucknow is
pending decision.

After the matter was remanded by the Supreme Court in the
case of CIT v. U.P. Forest Corporation, (1998) 3 SCC 530, the assessing
authority held that the appellant was not a charitable institution and assessed
the income in respect of the A.Ys. 1977-78, 1980-81 and 1984-85 to tax. The
Commissioner (Appeals) partly allowed the appeals of the appellant-corporation
granting some relief on issues of additions/deductions. The
appellant-corporation as also the Revenue filed appeals against the said order
before the Tribunal. The Tribunal allowed the appeals filed by the Revenue and
set aside the relief granted to the corporation on the issue of
additions/deductions, on the ground that this Court had remanded the matter only
to decide one issue. Being aggrieved, the corporation filed an appeal u/s.260A
of the Act before the High Court. The High Court remanded the matter to the
Tribunal for considering the matter afresh. Aggrieved by the said order, the
corporation filed appeal before the Supreme Court. The Revenue also filed an
appeal against the said order. The Revenue also challenged a subsequent order
passed by the High Court, wherein the above question had not been decided in
view of the pendency of the aforementioned appeals. The Supreme Court held that
for claiming benefit u/s.11(1)(a), registration u/s.12A is a condition
precedent. Unless and until an institution is registered u/s.12A of the Act, it
cannot claim the benefit of S. 11(1)(a) of the Act. Keeping in view the fact
that the appellant-corporation had not been granted registration u/s.12A of the
Act, it was held that the appellant was not entitled to claim exemption from
payment of tax u/s.11(1)(a) and u/s.12 of the Act. The Supreme Court dismissed
the appeals filed by the corporation without deciding the merits of the dispute.
In view of the dismissal of these appeals, the appeals filed by the Revenue were
also dismissed. However, in order to protect the interest of the assessee as
well as the Revenue, the Tribunal was directed to take up the matter on priority
basis and decide the same as expeditiously as possible without being influenced
by any of the findings recorded by the High Court in its order.

Nirav Shah

Full adoption of Accounting Standard 30 Strides Arcolab Ltd. (31-12-2008)

From Accounting Policies

Financial Assets, Financial Liabilities, Financial Instruments, Derivatives and Hedge Accounting

1. The Company classifies its financial assets into the following categories: financial instruments at fair value through profit and loss, loans and receivables, held to maturity investments and available for sale financial assets. Financial assets of the Company mainly include cash and bank balances, sundry debtors, loans and advances and derivative financial instruments with a positive fair value.

Financial liabilities of the Company mainly comprise secured and unsecured loans, sundry creditors, accrued expenses and derivative financial instruments with a negative fair value. Financial assets/liabilities are recognised on the balance sheet when the Company becomes a party to the contractual provisions of the instrument. Financial assets are derecognised when all of risks and rewards of the ownership have been transferred. The transfer of risks and rewards is evaluated by comparing the exposure, before and after the transfer, with the variability in the amounts and timing of the net cash flows of the transferred assets.

Available for sale financial assets (not covered under other Accounting Standards) are carried at fair value, with changes in fair value being recognised in Equity, unless they are designated in a Fair value hedge relationship, where such changes are recognised in the Profit and Loss account.

Loans and receivables, considered not to be in the nature of Short-term receivables, are discounted to their present value. Short-term receivables with no stated interest rates are measured at original invoice amount, if the effect of discounting is immaterial. Non-interest bearing deposits, meeting the criteria of financial asset, are discounted to their present value.

Financial liabilities held for trading and liabilities designated at fair value, are carried at fair value through profit and loss. Other financial liabilities are carried at amortised cost using the effective interest method. The Company measures the short-term payables with no stated rate of interest at original invoice amount, if the effect of discounting is immaterial.

Financial liabilities are derecognised when extinguished.

2. Determining fair value

Where the classification of a financial instrument requires it to be stated at fair value, fair value is determined with reference to a quoted market price for that instrument or by using a valuation model. Where the fair value is calculated using financial markets pricing models, the methodology is to calculate the expected cash flows under the terms of each specific contract and then discount these values back to a present value.

3. Derivative financial instruments

The Company is exposed to foreign currency fluctuations on foreign currency assets and liabilities. The Company limits the effects of foreign exchange rate fluctuations by following established risk management policies including the use of derivatives. The Company enters into forward exchange financial instruments where the counterparty is a bank. Changes in fair values of these financial instruments that do not qualify as a Cash flow hedge accounting are adjusted in the Profit and Loss.

4. Hedge Accounting

Some financial instruments and derivatives are used to hedge interest rate, exchange rate, commodity and equity exposures and exposures to certain indices. Where derivatives are held for risk management purposes and when transactions meet the criteria specified in Accounting Standard 30, the Company applies fair value hedge accounting or cash flow hedge accounting as appropriate to the risks being hedged.

5. Fair value hedge accounting

Changes in the fair value of financial instruments and derivatives that qualify for and are designated as fair value hedges are recorded in the Profit and Loss Account, together with changes in the fair value attributable to the risk being hedged in the hedged assets or liability. If the hedged relationship no longer meets the criteria for hedge accounting, it is discontinued.

From Notes to Accounts

6. Adoption of Accounting Standard-30 : Financial Instruments : Recognition and Measurement, issued by Institute of Chartered Accountants of India

Arising from the Announcement of the Institute of Chartered Accountants of India (ICAI) on March 29, 2008, the Company has chosen to early adopt Accounting Standard (AS) 30 :

‘Financial Instruments : Recognition and Measurement’. Coterminous with this, in the spirit of complete adoption, the Company has also implemented the consequential limited revisions in view of AS 30 to AS 2, ‘Valuation of Inventories’, AS 11’ The Effect of Changes in Foreign Exchange Rates’, AS 21 ‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements’, AS 23 ‘Accounting for Investments in Associates in Consolidated Financial Statements’, AS 26 ‘Intangible Assets’, AS 27 ‘Financial Reporting of Interests in Joint Ventures’, AS 28 ‘Impairment of Assets’ and AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’ as have been announced by the ICAI.

Consequent to adoption of AS 30 and the transitional provision under the standard :

The Company has changed the designation and measurement principles for all its significant financial assets and liabilities existing as at January 1, 2008. The impact on account of the above measurement of these is as described below :

6.1 Foreign Currency Convertible Bonds (FCCBs or Bonds)

On adoption of AS 30, the FCCBs are split into two components comprising (a) option component which represents the value of the option in the hands of the FCCB-holders to convert the bonds into equity shares of the Company and (b) debt component which represents the debt to be redeemed in the absence of conversion option being exercised by FCCB-holder, net of issuance costs. The debt component is recognised and measured at amortised cost while the fair value of the option component is determined using a valuation model with the below mentioned assumptions.

Assumptions used to determine fair value of the options:

Valuation and amortisation method – The Company estimates the fair value of stock options granted using the Black Scholes Merton Model and the principles of the Roll-Geske-Whaley extension to the Black Scholes Merton model. The Black Scholes Merton model along with the extensions above requires the following inputs for valuation of options:

Stock Price as at the date of valuation – The Company’s share prices as quoted in the National Stock Exchange Limited (NSE), India have been converted into equivalent share prices in US Dollar terms by applying currency rates as at valuationates. Further, stock prices have been reduced by continuously compounded stream of dividends expected over time to expiry as per the principles of the Black-Scholes Merton model with Roll Geske Whaley extensions.

Strike price for the option – has been computed in dollar terms by computing the redemption amount in US dollars on the date of redemption (if not converted into equity shares) divided by the number of shares which shall be allotted against such FCCBs.

Expected Term – The expected term represents time to expiry, determined as number of days between the date of valuation of the option and the date of redemption.

Expected Volatility – Management establishes volatility of the stock by computing standard deviation of the simple exponential daily returns on the stock. Stock prices for this purpose have been

6.1 Foreign Currency Convertible Bonds (FCCBs or computed by expressing daily closing prices as Bonds) quoted on the NSE into equivalent US dollar terms. For the purpose of computing volatility of stock prices, daily prices for the last one year have been considered as on the respective valuation dates.

Risk-Free Interest Rate – The risk-free interest rate used in the Black-Scholes valuation method is assumed at 7%.

Expected Dividend – Dividends have been assumed to continue, for each valuation rate, at the rate at which dividends were earned by shareholders in the last preceding twelve months before the date of valuation.

Measurement of Amortised cost of debt component:

For the purpose of recognition and measurement of the debt component, the effective yield has been computed considering the amount of the debt component on initial recognition, origination costs of the FCCB and the redemption amount if not converted into Equity Shares. To the extent the effective yield pertains to redemption premium and the origination costs, the effective yield has been amortised to the Securities Premium Account as permitted under section 78 of the Companies Act, 1956. The balance of the effective yield is charged to the Profit and Loss Account.

Consequent to change in policy for accounting of FCCBs,

a) Rs.934.71 Million being the previously accrued Debenture Redemption Reserve out of the Securities Premium Account has been credited back to Securities Premium Account.

b) Rs.124.68 Million being the amount of FCCB issue expenses previously debited to Securities Premium Account has been reversed.

c) Rs.443.20 Million and Rs.546.41 Million has been debited to Securities Premium Account as at December 31, 2007 and during the year 2008, respectively towards the amortised interest attributable to the effective yield pertaining to the redemption premium and FCCB issue expenses.

d) Rs.202 Million being the excess of amortised interest chargeable to Profit and Loss Account as per the policy adopted by the Company over the previously recognised interest cost upto December 31, 2007 has been debited to General Reserve Account.

e) Interest expense for the year debited to Profit and Loss Account is higher by Rs.216.48 Million, and Profit Before Tax for the year is lower by the corresponding amount.

f) The difference between the fair value of the option component on the date of issue of the FCCBs and December 31, 2007 amounting to Rs.427.10 Million has been credited to the General Reserve Account.

g) Rs.452.21 Million being the difference in the carrying amount of the option component between December 31, 2008 and December 31 2007 has been credited to the Profit and Loss Account of the year.

h) Rs.63.31 Million being the incremental exchange difference upto December 31, 2007 arising out of the accounting treatment of FCCBs described above has been debited to General Reserve Account. Exchange loss on restatement of FCCBs is lower and Profit Before Tax for the year is higher by Rs.101.54 Million.

6.2 Consequent to change in policies for accounting for External commercial borrowings (another financial liability), excess of amortised interest cost of Rs.0.53 Million and Rs.0.79 Million chargeable to Profit and Loss Account as per the policy adopted by the Company over the previously recognised interest cost for the period upto December 31, 2007 and for year ended December 31, 2008, respectively, has been debited to General Reserve Account and the Profit and Loss account respectively.

6.3 The financial assets and liabilities arising out of issue of corporate financial guarantees to third parties are accounted at fair values on initial recognition. Financial assets continue to be carried at fair values. Financial liabilities are subsequently measured at the higher of the amounts determined under AS 29 or the fair values on the measurement date. At December 31,2008, the fair values of such financial assets are equal to such liabilities and have been set off in the financial statements.

6.4 As required under the Companies Act, 1956, Redeemable Preference Shares are included as part of share capital and not as debt and dividend on the preference shares will be accounted as dividend as part of appropriation of profits and have not been accrued as interest cost. Further, due to inadequate profits, the Company has not accrued dividend of Rs. 29.50 Million each for the year ended December 31, 2007 and December 31, 2008, and the related Dividend distribution taxes.

6.5 Fully convertible debentures are considered as borrowings and are not disclosed as part of shareholder funds, and interest thereon of Rs.24.73 Million is debited to the Profit and Loss Account as interest cost as required under the Companies Act, 1956 and has not been treated as dividend.

Hedge Accounting:

The Company had prior to December 31, 2007 designated its investments in Starsmore Limited, Cyprus, Strides Africa Limited, British Virgin islands and Akorn Strides LLC, USA, whose functional currency is US dollars as hedged items in a fair value hedge and to the extent of the hedge items, designated FCCB’s availed in US dollars as hedging instruments, to hedge the risk arising from fluctuations in the foreign exchange rate between the Indian Rupee and the US dollar. The carrying values of the designa ted hedged iterns and the hedging instruments as at December 31, 2008 is USD 100.55 Million and USD 69.20 Million as at December 31, 2007.

Accordingly, applying the fair value hedge accounting principles, the exchange gains/ losses on the hedging instrument is recognised in Profit and Loss Account along with the associated exchange gains/losses on the restatement of the designated portion of the investments. The impact of exchange loss arising on restatement of designated portion of the USD investments as of December 31, 2007 amounted to Rs. 120.42 Million and has been debited to the General Reserve Account.

The exchange gains arising on restatement of designated portion of the USD investments for the year ended December 31, 2008 amounting to Rs. 923.40 Million has been treated as an effective fair value hedge since the loss arising on the dollar loans designated as hedging instruments amounted to a similar amount and such gains have been credited to the Profit and such gains have been credited to the Profit and Loss account for year ended December 31,2008.

Prior to the adoption of the AS 30 ‘Financial Instruments: Recognition and Measurement’, and the limited revisions to AS 21 ‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements’, investments in subsidiaries were valued at cost less diminution in value that was other than temporary as per the provisions of AS-13 ‘Accounting for Investments’ that was notified under section 21l(3C) of the Companies Act, 1956. As a result of above change in accounting policy, carrying value of investments as at December 31, 2008 is higher by Rs. 802.98 Million, profit for the year is higher by Rs. 923.40 Million and General Reserve is higher by Rs. 802.98 Million.

6.7 The Company has availed Bill Discounting facility from Banks which do not meet the de-recognition criteria for transfer of contractual rights to receive cash flows from the Debtors since they are with recourse to the Company.

Accordingly, as at December 31, 2008, Sundry Debtor balances include such amounts and the corresponding financial liability to the Banks is included as part of short term secured loans.

6.8 All the open derivative positions as on January 1, 2008 not designated as hedging instruments have been classified as held for trading and gains/losses recognised in the Profit and Loss Account. The incremental negative fair value of such derivatives over and above provision carried was Rs. 100.92 Million as at December 31,2007 which has been debited to the General Reserve Account. Incremental negative fair value of the open derivatives position as at December 31, 2008 amounting to Rs. 346.08 Million has been debited to Profi t and Loss Account for the year.

From Notes to Accounts (con’td.)

33. Disclosures relating to Financial instruments to the extent not disclosed elsewhere in Schedule P

Breakup of Allowance for Credit Losses is as under:

Details on Derivatives Instruments & Unhedged Foreign Currency Exposures

The following derivative positions are open as at December 31, 2008. While these transactions have been undertaken to act as economic hedges for the Company’s exposures to various risks in foreign exchange markets, they have not qualified as hedging instruments in the context of the rigour of such classification under Accounting Standard 30. Theses instruments are therefore classified as held for trading and gains/losses recognised in the Profit and Loss Account.

i. The Company had entered into the following derivative instruments:

a . Forward Exchange Contracts [being a derivative instrument), which are not intended for trading or speculative purposes, but for hedge purposes, to establish the amount of reporting currency required or available at the settlement date of certain payables and receivables.

The following are the outstanding Forward Exchange Contracts entered into by the Company as on December 31, 2008.

b) Interest Rate Swaps to hedge against fluctuations in interest rate changes: No. of contracts: Nil (Previous year: No. of contracts: 3, Notional Principal: USD 20 Million).c) Currency Swaps (other than forward exchange contracts stated above) to hedge against fluctuations in change in exchange rate.of contracts: Nil (Previous Year: No of contracts 6, Notional Principal: USD 80 Million).ii. The year end foreign currency exposures that have not been hedged by a derivative instrument or otherwise are given below:

iii. Derivative Instruments (causing an un-hedged foreign currency exposure) : Nil (Previous Year USD 8 Million – Sell)

iv. Losses on forward Exchange Derivate contracts (Net) included in the Profit and Loss account for year ended December 31, 2008 amount Rs.454.27 Million.

Categories of Financial Instruments

a) Loans and Receivables:

The following financial assets in the Balance Sheet have been classified as Loans and Receivables as defined in Accounting Standard 30. These are carried at amortised cost less impairment if any. The carrying amounts are as under:

In the opinion of the management, the carrying amounts above are reasonable approximations of fair values of the above financial assets.

b) Financial Liabilities Held at Amortised Cost

The following financial liabilities are held at amortised cost. The Carrying amount of Financial Liabilities is as under:

c) Financial Liabilities Held for Trading

The option component of Foreign Currency Convertible Bonds (FCCBs) has been classified as held for trading, being a derivative under Accounting Standard 30. Refer Note B.6 of Schedule P on FCCBs. The carrying amount of the option component was Rs.134.20 Million as at December 31,2008 and Rs.586.42 Million as at December 31, 2007. The difference in carrying value between the two dates, amounting to Rs.452.21 Million is taken as gain to the Profit and Loss Account of the year in accordance with provisions of Accounting Standard 30.

The fair value of the option component has been determined using a valuation model. Refer to Note B.6 above on FCCBs for detailed disclosure on the valuation method.

d) There are no financial assets in the following categories:

o Financial assets carried at fair value through profit and loss designated at such at initial recognition.

o Held to maturity

o Available for sale

o Financial liabilities carried at fair value through profit and loss designated as such at initial recognition.

Financial assets pledged

The following financial assets have been pledged:

Financial Asset		Carrying value Dec. 31, 2007	Carrying value Dec. 31, 2007	Liability/Contingent Liability for which pledged as collateral	Terms and conditions relating to pledge
I. Margin Money with Banks
A. Margin Money for Letter of Credit		80.89	82.87	Letter of Credit	The Margin Money is interest bearing deposit with Banks. These deposits can be withdrawn on the maturity of all Open Letters of Credit.

B. Margin Money for		26.31	6.29	Bank Guarantee	The	Margin			Money		is
Bank Guarantee					interest		bearing			deposit
					with	Banks.				These
					Deposits			are		against
					Performance				Guarantees.
					Theses can be withdrawn
					on the satisfaction of the
					purpose		for		which		the
					Guarantee		is		provided.
C. Other	Margin Money		11.82	Margin Money	The	Margin			Money		is
				as Guarantee for	interest		bearing			deposit
				Loan to	with	Banks.		This		Deposit
				Subsidiary	is against		Guarantees				for
					Loan		advanced				to
					Subsidiary.			This		deposit
					has	been	withdrawn				on
					the	repayment				of	the
					Loan	by	the		Subsidiary.
II. Sundry	debtors	974.61	651.61	Bills discounted	The	Bills discounted with
					Banks are secured by the
					Receivable.

Nature and extent of risk arising from financial instruments

The main financial risks faced by the Company relate to fluctuations in interest and foreign exchange rates, the risk of default by counterparties to financial transactions, and the availability of funds to meet business needs. The Balance Sheet as at December 31, 2008 is representative of the position through the year. Risk management is carried out by a central treasury department under the guidance of the Management.

Interest rate risk

Interest rate risk arises from long term borrowings. Debt issued at variable rates exposes the company to cash flow risk. Debt issued at fixed rate exposes the company to fair value risk. In the opinion of the management, interest rate risk during the year under report was not substantial enough to require intervention or hedging through derivatives or other financial instruments. For the purposes of exposure to interest risk, the company considers its net debt position evaluated as the difference between financial assets and financial liabilities held at fixed rates and floating rates respectively as the measure of exposure of notional amounts to interest rate risk. This net debt position is quantified as under:

Particulars		2008	2007
Fixed
Financial	Assets ………………….	301.02	……… 745.74
Financial	liabilities ………..	(7,123.32)	…. (7,665.91)
		(6,822.30)	…. (6,920.17)
Floating
Financial	Assets ………………….	229.20	……… 196.26
Financial	liabilities ………..	(3,717.10)	…. (2,961.78)
		(3,487.90)	…. (2,769.52)

Credit risk

Credit risk arises from cash and cash equivalents, financial instruments and deposits with banks and financial institutions. Credit risk also arises from trade receivable and other financial assets.

The credit risk arising from receivable is subject to concentration risk in that the receivable are predominantly denominated in USD and any appreciation in the INR will affect the credit risk. Further, the Company is not significantly exposed to geographical distribution risk as the counter-parties operate across various countries across the Globe.

Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to Company’s reputation. liquidity risk is managed using short term and long term cash flow forecasts.

The following is an analysis of undiscounted contractual cash flows payable under financial liabilities and derivatives as at December 31, 2008 :

Financial Liabilities			Due within
	1 year	1 and	2 and	3 and	4 and
		2 years	3 years	4 years	5 years
Bank Borrowings	2,860.74	369.43	279.97	182.59	91.29
Interest payable on borrowings	0.08	–	–	–	–
Hire Purchase liabilities	2.48	2.23	0.41	0.13	–
Other Borrowings	–	2,306.64	–	4,744.43	–
Trade and other payables not in net debt	1,985.95	–	–	–	–
Fair Value of Options embedded in FCCBs	–	11.06	–	123.15	–
Fair value of Forward exchange derivative contracts	174.12	165.61	–	–	–
Total	5,023.37	2,689.36	280.38	5,050.30	91.27

For the purposes of the above table, undiscounted cash flows have been applied. Undiscounted cash flows will differ from fair values. Foreign currency liabilities have been computed applying spot rates on the Balance Sheet date.

Foreign exchange risk
The Company is exposed to foreign exchange risk principally via:

o Debt availed in foreign currency

o Net investments in subsidiaries and joint ventures that are made in foreign currencies.

o Exposure arising from transactions relating to purchases, revenues, expenses etc to be settled in currencies other than Indian Rupees, the functional currency of the respective entities.

The Company had designated its investments in certain subsidiaries whose functional currency is US dollars as hedged items in a fair value hedge and certain loans availed in US dollars as hedging instruments to hedge the risk arising from fluctuations in the foreign exchange rate between the Indian Rupee and the US dollar. The carrying values of the financial liabilities designated as hedging instruments as at December 31, 2008 is Rs.4,897.97 Million.

The loss arising on the dollar loans designated as hedging instruments recognised in the Profit and Loss Account for the year ended December 31, 2008 is Rs.923.40 Million. The gain arising from investments in certain subsidiaries designated as hedged items as much as is attributable to the hedged foreign exchange risk recognised in the Profit and Loss Account for the year ended December 31, 2008 is Rs.923.40 Million.

Sensitivity analysis as at December 31, 2008

Financial instruments affected by interest rate changes include Secured Long term loans from banks, Secured Long term loans from others, Secured Short term loans from banks and Secured Short term loans from banks. The impact of a 1% change in interest rates on the profit of an annual period will be Rs.108.29 Million assuming the loans as of December 31, 2008 continue to be constant during the annual period. This computation does not involve a revaluation of the fair value of loans as a consequence of changes in interest rates. The computation also assumes that an increase in interest rates on floating rate liabilities will not necessarily involve an increase in interest rates on floating rate financial assets.

Financial instruments affected by changes in foreign exchange rates include FCCBs, External Commercial Borrowings (ECBs), investments in subsidiaries, loans in foreign currencies to erstwhile subsidiaries and loans to subsidiaries and joint ventures. The company considers US Dollar and the Euro to be principal currencies which require monitoring and risk mitigation. The Company is exposed to volatility in other currencies including the Great Britain Pounds (GBP) and the Australian Dollar (AUD).

For the purposes of the above table, it is assumed that the carrying value of the financial assets and liabilities as at the end of the respective financial years remains constant thereafter. The exchange rate considered for the sensitivity analysis is the Exchange Rate prevalent as a December 31, 2008.

In the opinion of the management, impact arising from changes in the values of trading assets (including derivative contracts, trade receivable, trade payables, other current assets and liabilities) is temporary and short term in nature and would vary depending on the levels of these current assets and liabilities substantially from time to time and even on day to day basis and hence are not useful in an analysis of the long term risks which the Company is exposed to.

This is the first year of adoption of Accounting Standard 3D, consequently comparative figures relating to 2007 in respect of disclosures under Accounting Standard 30 have been provided only where such information is available.

From Auditors’ Report

d) The Company has early adopted Accounting Standard 30 ‘Financial Instruments: Recognition and Measurement’, along with the limited revision to Accounting Standard 2 ‘Valuation of Inventories’, Accounting Standard 11 ‘The Effect of Changes in Foreign Exchange Rates’, Accounting Standard 21 ‘Consolidated Financial Statements and Accounting for Investment in Subsidiaries in Separate Financial Statements’, Accounting Standard 23 ‘Accounting for Investments in Associates in Consolidated Financial Statements’, Accounting Standard 26 ‘Intangible Assets’, Accounting Standard 27 ‘Financial Reporting of Interest in Joint Ventures’, Accounting Standard 28 ‘Impairment of Assets’, and Accounting Standard 29 ‘Provisions, Contingent Assets and Contingent Liabilities, arising from the announcement of the Institute of Chartered Accountants of India on 29 March 2008, as stated in Note B.6 of Schedule P to the financial statements. Pursuant to the above, as detailed in note B.6.6 of Schedule P to the financial statements, certain US Dollar investments in subsidiaries and joint ventures have been designated as hedged items in a fair value hedge for changes in spot rates and have been restated at the closing exchange rate at December 31, 2008 and a credit of Rs. 923.40 Million has been recognised in the Profit and Loss Account, as compared to the earlier policy of valuing these investments at cost less diminution that is other than temporary, as required under Accounting Standard 13 ‘Accounting for Investments’, notified under section 211 (3C) of the Companies Act, 1956.

e) read with our comments in paragraph (d) above, in our opinion, the Balance Sheet, the Profit and Loss Account and the Cash Flow Statement dealt with by this report comply with the Accounting Standards referred to in sub-Section (3C) of Section 211 of the Companies Act, 1956.

From Management Discussions and Analysis

Early adoption of Accounting Standard 30 and IFRS convergence

The Company has early adopted Accounting Standard 30 : Financial Instruments: Recognition and Measurement and the consequential limited revisions to other applicable Accounting Standards as have been announced by the ICAI. Accordingly, the Company has changed the designation and measurement principles for all its significant financial assets and liabilities including FCCBs and ECBs. In case where there are conflicts between provisions of AS 30 and Companies Act, 1956, provisions of Companies Act, 1956 have been followed.

Detailed disclosures in this regard have been made in Note 1.11 of Part A, Note 6 and 33 of Part B of Schedule – ‘P’ to the financial statements forming part of the Annual Report.

Accounting Standards 30, 31 and 32 are new accounting Standards, to be made mandatory from April 01, 2011. These are global standards in line with IAS 39, as a prelude to IFRS Convergence. By adopting Accounting Standard 30 the company is progressing towards IFRS convergence.

Nirav Shah

Wipro Ltd.

New Page 1

WIPRO LTD. —
(31-3-2008) (consolidated)

From Accounting Policies :

Foreign currency transactions :

The Company is exposed to currency fluctuations on foreign
currency transactions. Foreign currency transactions are accounted in the books
of accounts at the average rate for the month.

Transaction :

The difference between the rate at which foreign currency
transactions are accounted and the rate at which they are realised is recognised
in the profit and loss account.

Translation :

Monetary foreign currency assets and liabilities at
period-end are translated at the closing rate. The difference arising from the
translation is recognised in the profit and loss account.

Derivative instruments and Hedge accounting :

The Company is exposed to foreign currency fluctuations on
foreign currency assets and forecasted cash flows denominated in foreign
currency. The Company limits the effects of foreign exchange rate fluctuations
by following established risk management policies including the use of
derivatives. The Company enters into forward exchange and option contracts,
where the counterparty is a bank. Since March 2004, based on the principles set
out in International Accounting Standard (IAS 39) on Financial Instruments’ the
Company has designated forward contracts and options to hedge highly probable
forecasted transactions as cash flow hedges. The exchange differences relating
to these forward contracts and gains/losses on such options were being
recognised in the period in which the forecasted transactions were expected to
occur. The exchange differences relating to forward contracts/options, other
than designated forward contracts/ options, were recognised in the profit and
loss account as they arose.

Effective April 1, 2007, based on the recognition and
measurement principles set out in the Accounting Standard (AS) 30 on Financial
Instruments: Recognition and Measurement, the changes in the fair values of
forward contracts and options designated as cash flow hedges are recognised
directly in shareholders’ funds and are reclassified into the profit and loss
account upon the occurrence of the hedged transaction. The gains/losses on
forward contracts and options designated as cash flow hedges are included along
with the underlying hedged forecasted transactions. The changes in fair value
relating to the ineffective portion of the cash flow hedges and forward
contracts/options not designated as cash flow hedges are recognised in the
profit and loss account as they arise. The Company has also designated forward
contracts and options as hedges of net investment in non-integral foreign
operation. The portion of the changes in fair value of forward contracts and
options that is determined to be an effective hedge is recognised in
shareholders’ fund and would be recognised in profit and loss account on the
disposal of foreign operation. The portion of the changes in fair value of
forward contracts and options that is determined to be an ineffective hedge is
recognised in the profit and loss account.

The Institute of Chartered Accountants of India (ICAI) has
recently issued an announcement ‘Accounting for Derivatives’ on accounting for
derivatives and early adoption of AS 30. The Company has already been applying
the principles of AS 30 in accounting for derivative instruments and the
announcement did not have any impact on the Company.

Integral operations :

In respect of integral operations, monetary assets and
liabilities are translated at the exchange rate prevailing at the date of the
balance sheet. Non-monetary items are translated at the historical rate. The
items in the profit and loss account are translated at the average exchange rate
during the period. The differences arising out of the translation are recognised
in the profit and loss account.

Non-integral operations :

In respect of non-integral operations, assets and liabilities
are translated at the exchange rate prevailing at the date of the balance sheet.
The items in the profit and loss account are translated at the average exchange
rate during the period. The differences arising out of the translation are
transferred to translation reserve.

From Notes to Accounts :

The Company designated forward contracts and options to hedge
highly probable forecasted transactions based on the principles set out in
International Accounting Standard (IAS 39) on Financial Instruments :
Recognition and Measurement. Until March 31, 2007, the exchange differences on
the forward contracts and gain/loss on such options were recognised in the
profit and loss account in the periods in which the forecasted transactions were
expected to occur.

Effective April 1, 2007, based on the recognition and
measurement principles set out in the Accounting Standard (AS) 30 on Financial
Instruments : Recognition and Measurement, the changes in the derivative fair
values relating to forward contracts and options that are designated as
effective cash flow hedges are recognised directly in shareholders’ funds until
the hedged transactions occur. Upon occurrence of the hedged transactions the
amounts recognised in the shareholders’ funds would be reclassified into the
profit and loss account along with the underlying hedged forecasted
transactions. During the year ended March 31, 2008 the Company has reclassified
net exchange gains of Rs.951 Million along with the underlying hedged forecasted
transaction. In addition, the Company also designates forward contracts as
hedges of the net investment in non-integral foreign operations. The changes in
the derivative fair values relating to forward contracts and options that are
designated as net investments in non-integral foreign operations have been
recognised directly in shareholders’ funds within translation reserve. The
gains/losses in shareholders’ funds would be transferred to profit and loss
account upon the disposal of non-integral foreign operations.

Nirav Shah

Infosys Technologies Ltd.

New Page 1INFOSYS TECHNOLOGIES LTD.

— (31-3-2008)

From Accounting Policies :

Foreign currency transactions :

Revenue from overseas clients and collections deposited in
foreign currency bank accounts are recorded at the exchange rate as of the date
of the respective transactions. Expenditure in foreign currency is accounted at
the exchange rate prevalent when such expenditure is incurred. Disbursements
made out of foreign currency bank accounts are reported at the daily rates.
Exchange differences are recorded when the amount actually received on sales or
actually paid when expenditure is incurred, is converted into Indian Rupees. The
exchange differences arising on foreign currency transactions are recognised as
income or expense in the period in which they arise.

Fixed assets purchased at overseas offices are recorded at
cost, based on the exchange rate as of the date of purchase. The charge for
depreciation is determined as per the company’s accounting policy.

Monetary current assets and monetary current liabilities that
are denominated in foreign currency are translated at the exchange rate
prevalent at date of the balance sheet. The resulting difference is also
recorded in the profit and loss account.

Forward contracts and options in foreign

currencies :

The company records the gain or loss on effective hedges in
the foreign currency fluctuation reserve until the transactions are complete. On
completion, the gain or loss is transferred to the profit and loss account of
that period. To designate a forward contract or option as an effective hedge,
management objectively evaluates and evidences with appropriate supporting
documents at the inception of each contract whether the contract is effective in
achieving off-setting cash flows attributable to the hedged risk. In the absence
of a designation as effective hedge, a gain or loss is recognised in the profit
and loss account.

From Notes to Accounts :

Forward contracts outstanding :

Nirav Shah

Reliance Petroleum Ltd.

New Page 1RELIANCE PETROLEUM LTD.

— (31-3-2008)

From Accounting Policies :

Derivative Transactions :

In respect of Derivative Contracts, premium paid, provision
for losses on restatement and gains/losses on settlement are recognised along
with the underlying transactions and charged to Profit and Loss Account/Project
Development Expenditure Account.

From Notes to Accounts :

Financial and Derivative Instrument :

(a) Nominal amount of derivative contracts entered into by
the Company for hedging currency and interest rate related risks and
outstanding as on 31st March 2008 amounts to Rs.77330187080 (Previous year
Rs.47122063440). Category wise break-up is given below :

In Rupees

Particulars	As at 31-3-2008	As at 31-3-2007
1 Interest rate swaps	44132000000	10867500000
2 Currency swaps	14470737830	10500000000
3 Options	12053125000	24114330450
4 Forward Contracts	6674324250	1640232990

(b) All financial and derivative contracts entered into by
the Company are for hedging purposes only.

(c) In respect of outstanding derivative contracts which
are stated in para ‘a’ above, there is a net unrealised gain as on 31st March,
2008 which has not been recognised in the books, considering the principles of
prudence as enunciated in Accounting Standard 1 “Disclosure of Accounting
Policies” notified in the Companies (Accounting Standards) Rules 2006.

(d) Foreign currency exposures that are not hedged by
derivative or forward contracts as on 31st March 2008 amounts to
Rs.108075292858 (Previous year Rs.43470000000).

levitra

Nirav Shah

Tata Consulting Services Ltd.

New Page 1TATA
CONSULTING SERVICES LTD.

— (31-3-2008) (Consolidated)

From Accounting Policies :

Foreign currency transactions :

Income and expenses in foreign currencies are converted at
exchange rates prevailing on the date of the transaction. Foreign currency
monetary assets and liabilities other than net investments in non-integral
foreign operations are translated at the exchange rate prevailing on the balance
sheet date. Exchange difference arising on a monetary item that, in substance,
forms part of an enterprise’s net investments in a non-integral foreign
operation are accumulated in a foreign currency translation reserve.

Premium or discount on forward contracts and currency options
are amortised and recognised in the profit and loss account over the period of
the contract. Forward contracts and currency options outstanding at the balance
sheet date, other than designated cash flow hedges, are stated at fair values
And any gains or losses are recognised in the profit and loss account.

For the purpose of consolidation, income and expenses are
translated at average rates and the assets and liabilities are stated at closing
rate. The net impact of such change is disclosed under Foreign exchange
translation reserve.

Derivative instruments and hedge accounting :

The Company uses foreign currency forward contracts and
currency options to hedge its risks associated with foreign currency
fluctuations relating to certain firm commitments and forecasted transactions.
The Company designates these hedging instruments as cash flow hedges applying
the recognition and measurement principles set out in the Accounting Standard 30
‘Financial Instruments : Recognition and Measurement’ (AS-30).

The use of hedging instruments is governed by the Company’s
policies approved by the board of directors, which provide written principles on
the use of such financial derivatives consistent with the Company’s risk
management strategy.

Hedging instruments are initially measured at fair value, and
are re-measured at subsequent reporting dates. Changes in the fair value of
these derivatives that are designated and effective as hedges of future cash
flows are recognised directly in shareholders’ funds and the ineffective portion
is recognised immediately in profit and loss account.

Changes in the fair value of derivative financial instruments
that do not qualify for hedge accounting are recognised in profit and loss
account as they arise.

Hedge accounting is discontinued when the hedging instrument
expires or is sold, terminated, or exercised, or no longer qualifies for hedge
accounting. At that time for forecasted transactions, any cumulative gain or
loss on the hedging instrument recognised in shareholder’s funds is retained
there until the forecasted transaction occurs. If a hedged transaction is no
longer expected to occur, the net cumulative gain or loss recognised in
shareholders’ funds is transferred to profit and loss account for the period.

From Notes to Accounts :

Derivative financial instruments :

TCS Limited, in accordance with its risk management policies
and procedures, enters into foreign currency forward contracts to mange its
exposure in foreign exchange rates. The counter party is generally a bank. These
contracts are for a period between one day and eight years.

During the year ended March 31, 2008, TCS Limited has
re-evaluated its risk management program and hedging strategies in respect of
forecasted transactions. Upon completion of the formal documentation and testing
for effectiveness, TCS Limited has designated certain foreign currency options
in respect of forecasted transactions, which meet the hedging criteria, as Cash
Flow Hedges:

TCS Limited has following outstanding derivative instruments
as on March 31, 2008 :

(i) The following are outstanding Foreign Exchange Forward
contracts, which have been designated as Cash Flow Hedges, as on :

The following are outstanding Currency Option contracts, which have been designated as Cash Flow Hedges, as on :

Net loss on derivative instruments of Rs.21.83 crores recognised in Hedging Reserve as on March 31, 2008 is expected to be reclassified to the Profit and loss account by March 31, 2009.

The movement in Hedging Reserve during period ended March 2008, for derivatives designated as Cash Flow Hedges is as follows:

In addition to the above cash flow hedges, the Company has outstanding foreign exchange forward contracts and currency option contracts aggregating Rs.2,141.90 crores (previous year: Rs.2062.61 crores), whose fair value showed a loss of Rs.4.46 crores as on March 31, 2008 (previous year: gain of Rs.9.22 crores) to hedge the future cash flows. Although these contracts are effective as hedges from an economic perspective, they do not qualify for hedge accounting and accordingly these are accounted as derivatives instruments at fair value with changes in fair value recorded in the Profit and Loss Account.

Exchange gain of Rs.283.96 crores (previous year gain of Rs.45.13 crores) on foreign currency forward exchange contracts have been recognised in the period ended March 31, 2008.

Nirav Shah

Taxing times — IFRS and Taxation

IFRS

On 22 January 2010, the Ministry of Corporate Affairs (MCA)
in India issued a press release setting out the roadmap for International
Financial Reporting Standards (IFRS) convergence in India.

It is now a widely held view that in addition to accounting
issues, transition to IFRS would trigger implications under various
legislations, including taxes, corporate laws and other regulations.

Through this article we aim to bring to light a few key
direct tax issues that are likely to arise when companies transition to IFRS.

Potential additional areas of differences between book
profits (per IFRS) and taxable profits :

Accounting policies and practices for many transactions will
change on convergence with IFRS. The discussion below provides an illustrative
listing of items involving a change in accounting, where the tax implications of
the change need to be evaluated. Several additional changes may require a
similar assessment from a taxation perspective.

Treatment of dividend and premium on redemption of preference shares :

Currently preference shares are treated as part of share
capital, consequently the dividend on preference shares is charged to the
profit and loss appropriation account. Under IFRS, preference shares will be
treated as a financial liability and dividend thereon will be in the nature of
a finance expense. Under Indian GAAP, the premium or discount on redemption of
preference shares is adjusted from the securities premium account. IFRS
requires such premium or discounts to be charged to the income statement.

Presently, dividend and premium on redemption of preference
shares is considered to be capital in
nature and hence not tax deductible.

The Government would need to clarify whether such costs
charged to income statement would be allowed as a tax deductible expense.

Also, this would lead to reduction in the tax liability of
a company under MAT provisions. The Government would need to clarify whether
this would be acceptable from a tax perspective.

Stock compensation cost :

Under Indian GAAP, the employee stock options are
recognised at their intrinsic value. IFRS requires the stock options to be
recognised at their fair value. The impact of the same will be in the employee
cost.

The Government would need to clarify whether the employee
costs resulting from fair valuation of the stock option will be a deductible
expense.

Cost of stock options granted by a related entity to
employees of the reporting entity would need to be recorded e.g. : companies
would need to accrue for notional compensation cost for options granted by
parent to subsidiary employees with a corresponding impact on the cost of
investments or dividend distribution, respectively.

The Government would need to consider the deductibility of
such compensation cost in the hands of the entity receiving the grant and
impact on cost of acquisition for tax purposes to compute capital gain tax or
tax impact on dividend distribution in the hands of the entity giving the
grant.

Unrealised gains and losses :

IFRS requires all financial assets and liabilities to be
measured initially at fair value. Subsequent measurement of the financial
instrument would depend on their classification. This accounting treatment
results in unrealised gains and losses in the income statement. For instance —
all derivatives will have to be fair valued at each reporting date and the
gain or loss on such fair valuation is charged to the income statement (unless
hedge accounting is followed).

The Government would need to clarify whether the unrealised
gains and losses will be taxable in the reporting period in which they arise.
This may pose difficulty to entities, given that they may not have the
liquidity to settle the tax dues on these unrealised gains. Alternatively, the
Government could tax these instruments based on the actual realised gains or
losses.

Further, the Government would also need to consider the tax
implications of unrealised gains/losses on financial instruments which are
permitted to be adjusted directly in the reserves without impacting the income
statement. For example : Unrealised gains/losses related to available for sale
(AFS) securities and effective portion of cash flow hedges are recognised
through other comprehensive income within equity.

Taxation of notional gains and expenses :

In many instances, the accounting treatment envisaged by
IFRS could result in recognition of notional gains and expenses. The following
are examples of instruments which could give rise to notional gains or
expenses :

(1) Low interest or interest-free loans to employees —
Loans given to employees at lower than market interest rates should be
measured at fair value which is the present value of anticipated future cash
flows discounted using a market interest rate. Any difference between the fair
value of the loan and the amount advanced shall be a prepaid employee benefit.
The Government will need to consider implication of tax deducted at source on
salaries.

(2) Inter-group loans, advances and deposits at
concessional interest rates — If low interest/interest-free loans and
deposits have been forwarded among group entities, the loan or deposit is
initially measured at fair value using market rate of interest. Thus, where
the parent has granted a loan to the subsidiary, in the separate financial
statements of the parent, the difference between the nominal value and fair
value of the loan should be recognised as an additional investment in the
subsidiary and notional interest income is recognised by the parent and
corresponding interest expense by the subsidiary during the loan period. On
the other hand, where a loan has been given by the subsidiary to the parent,
in the separate financial statements of the subsidiary, the difference shall
be accounted for as dividend distribution to the parent and notional interest
income is recognised by the subsidiary and interest expense by the parent
company.

The Government will need to consider the taxation aspects of these notional interest and expenses and also implications on provision for tax deducted at source for such interest. Authorities will also need to consider impact on cost of acquisition for tax purposes to compute capital gain tax or tax impact on dividend distribution in the hands of the entity giving the loan at concessional interest rate.

   Interest-free security deposit on leasing arrangements — If an interest-free deposit is given as part of leasing transaction, the interest-free deposit will have to be discounted at the market rate and the difference will be treated initially as prepaid rent. The prepaid rent will be amortised to the income statement over the life of the lease.

The Government will have to clarify the tax treatment for such notional gains and expenses. Also the Government will need to consider implications on provision for tax deducted at source on rent.

   Revenue recognition :

Some of the revenue recognition principles under IFRS are different and will need to be carefully evaluated from tax perspective. For example :

   Under IFRS, if a contract contains multiple elements which have stand-alone value to the customer, the contract will have to be split and only revenue relating to the delivered component will be recorded in the reporting period. Further, the split of revenue between components will have to be done based on their relative fair values. For instance, if an entity sells machinery along with operations and maintenance services (O&M) for the machinery, the entity can recognise the fair value of the machinery in the reporting period in which the risk and rewards of the machinery are transferred to the buyer and the revenue from operations and maintenance will be deferred and recognised over the life of the O&M contract. The Government would need to clarify whether the entity will be taxed upfront only on the revenue recognised in a reporting period, or also on the deferred portion of the contract or will the tax impact of the deferred income also be deferred and taxed in the year in which such income is recognised in the accounts.

   In some cases two or more transactions may be linked so that the individual transactions have no commercial effect on their own. In these cases, IFRS requires that the combined effect of the two transactions together is ac-counted for. For instance a telecom company may sell mobile subscription to the customer and charge them the activation fees and talk time separately. However, in practice, these are linked transaction and the activation fee does not have any stand-alone value to the customer (in absence of the talk time or subscription agreement). Thus the telecom operator cannot recognise the activation revenue upfront and will have to defer it over the average life of the subscription agreement. The Government would need to clarify the method of taxation in such cases and consider to defer the tax implications in consonance with the deferral of revenue.

   IFRS provides guidance on accounting treat-ment of service concession agreements. For concession agreements, the contractor recognises certain profit (unrealised) dur-ing the construction phase and the balance during the operations phase when realised e.g., Company incurs cost of Rs.1,000 for construction of road and in consideration for the same has received a right to charge toll of Rs.30 on all vehicles plying on that road for 30 years (after which the road is handed over to the Government body). Under Indian GAAP, Company would capitalise Rs.1,000 as a fixed asset and depreciate it over 30 years.

However under IFRS, Company would need to accrue a notional margin on the construction activity as well and the cost of Rs.1,000 plus 10% margin (assumption) i.e., Rs.1,100 will be accounted as an intangible asset and amor-tised over 30 years. Although the manner of accounting will not result in any change in the total amount of profit or loss from the contract during the concession period (since the notional gain of 10% margin is offset by higher amortisation charge over the concession period), the proportion of the profit or loss over different reporting periods within the concession arrangement may differ.

The Government would need to consider the method of taxation in such cases. In this in-stance, entities may need to recognise profit margins upfront, though they would not have received cash inflows from the customers, thus entities may not have sufficient liquidity to settle tax dues, in case tax is charged based on the net profit reported in the financial statements.

Minimum Alternate Tax (‘MAT’) :

In case companies in India do not have sufficient taxable profits in India, as per the Income-tax Act companies are required to pay MAT as a specified percentage of book profits. Further, the new direct tax code proposes to charge MAT as a specified percentage of the total assets of the company.

Various differences discussed above and in particular the fair value implications and notional gains/ losses would have substantial impact on the reported profits or reported assets by companies.

The Government would need to assess the implications of such impacts on the tax liability arising due to provision of MAT, given that companies may find it difficult to pay tax dues (actual cash outflow) on unrealised gains which have not yet resulted in cash inflows for the company.

Further the proposal to charge MAT as a percentage of asset poses the following challenges for companies converging with IFRS, which need to be considered by tax authorities in formulating appropriate provisions :
   IFRS provides an option to account for its property, plant and equipment and investment properties at fair value at each reporting date. This could also result in increase in tax liability without any cash inflow to the company.

   Under IFRS, companies may need to account for certain embedded leases in normal sale/ purchase transactions e.g., Company has contracted to buy the entire output from suppliers production line and also given a minimum commitment to reimburse the fixed cost including capital cost of the supplier (these arrangements are commonly used as take or pay arrangement), in such cases, companies will need to account the production plant of the supplier as its own plant. This would increase the gross asset base of the Company and the corresponding MAT liability.

The above, being notional accounting aspects would cause significant issues for companies, if these are considered for taxing the entities and result in potential cash outflows.

The taxation model needs to be framed to ensure that companies that are required to follow the IFRS converged standards are not at a disadvantage as compared to other entities that are not required to follow the IFRS converged standards from April 1, 2011.

Matters for consideration by the Government :

Overall the Government will need to consider how to incorporate the implications of IFRS in the tax rules to be applied by companies, such that they do not result in unintended difficulties and adverse cash flow implications for companies.

The options to be considered to manage this transition :

Option 1 — Taxation based on current Indian accounting standards :
Require companies to prepare reconciliation of profit reported/assets reported under IFRS with profits and assets per the current accounting standards. Taxation based on such reconciled profits, assets and book balances. This is also generally followed in many of the European countries where taxation is determined based on the GAAP of the respective countries. For example : Germany, Spain.

Option 2 — Taxation based on IFRS with additional differences between IFRS financial statements and taxable income :

IFRS financial statements as a starting point for taxation. However, tax laws to be modified to identify additional areas where taxation (both current taxation and MAT) will be different from the basis used in the IFRS financial statements. These areas may be limited in number, and would not necessarily cover all differences that arise due to transition from current accounting standards to the IFRS converged standards. Additionally, under Option 2, the Government would need to determine how the one-time adjustments recorded in the books of accounts to transition to IFRS are treated for tax purposes.

It is important to note that the Income-tax Act in India applies to all entities i.e., corporate, partnership firms, trusts, individuals, etc. and IFRS will be applicable from 1st April 2011 only for a limited number of companies covered by Phase 1. If Option 2 is followed, this would result in different IFRS-based taxable models for some entities and a different model for other entities (that are not required to converge with IFRS immediately).

While Option 1 appears to be attractive, it poses challenges relating to maintaining two sets of records — one under IFRS and the other under current accounting standards. The benefits and costs of each of these options may need to be further debated to decide the best option from an Indian perspective.

Nirav Shah

Business Combinations (IFRS 3) — Accounting to reflect the economic substance

Nirav Shah

Interest : S. 234B of I. T. Act, 1961 : A. Ys. 1989-90 to 2000-01 : Interest u/s. 234B is compensatory in nature: Interest not leviable where there is no loss of revenue to Government.

New Page 1

Interest : S. 234B of I. T. Act, 1961 : A. Ys. 1989-90
to 2000-01 : Interest u/s. 234B is compensatory in nature: Interest not
leviable where there is no loss of revenue to Government.

[CIT vs. Anand Prakash; 179 Taxman 44 (Del)].

In 1989, the assessee’s land was acquired by the State
Government. Order enhancing compensation was passed on 04/04/2000. Enhanced
amount included interest relatable to A. Ys. 1989-90 to 2000-01. Interest was
assessed in the respective years by invoking the provisions of section 147 of
the Income-tax Act, 1961. The Assessing Officer also levied interest u/s. 234B
on the ground of short payment of advance tax. The Tribunal observed that at
the time when the assessee filed his return of income for all the relevant
years, there was no order for grant of interest on additional compensation and
the right to receive additional sums came to the assessee’s knowledge by the
order dated 04/04/2000 which was much later than the dates of completion of
the assessments. The Tribunal held that chargeability of interest was in the
nature of quasi punishment and, therefore, should not be imposed
retrospectively. The Tribunal accordingly, deleted the interest so charged.

On appeal by the Revenue, the Delhi High Court held as
under :

“i) The levy u/s. 234B is compensatory in nature and is
not in the nature of penalty.

ii) Although the conclusion of the Tribunal with regard
to the levy of interest u/s. 234B being penal in nature was not correct, yet
the ultimate conclusion arrived at by the Tribunal could not be interfered
with, because interest u/s. 234B is clearly by way of compensation. What the
revenue proposed to do in the facts and circumstances of the case was to
charge interest for the default in payment of advance tax in the years in
question. It can only justify such levy of charge if it has suffered a loss.
This follows from the conclusion that the levy of interest u/s. 234B is
compensatory in nature.

iii) The fact remained that no money belonging to the
Government was withheld by the assessee in the years in question. In fact,
the interest payable on account of the enhanced compensation was not even in
the knowledge of the assessee till completion of the assessments. The
assessee could not be expected to have paid advance tax on something which
had not been received by him and which would not have been in his
contemplation. In other words, the assessee could not have included the
interest received on enhanced compensation in the A. Y. 2001-02 while
estimating his income for the purpose of calculation of advance tax for the
relevant years.

iv) It is a well-known principle that the law cannot
compel any one to do the impossible. The Government, itself, on the one
hand, delayed the payment of compensation to the assessee and on the other
hand, it expected to levy interest on the assessee for having allegedly
defaulted in making payment towards the advance tax. The revenue had not
suffered any loss and, therefore, there could be no question of levying
interest u/s. 234B”.

levitra

Nirav Shah

Writ petition — Even if small fraction of cause of action accrued within the territories of a State, the High Court of that State will have jurisdiction

New Page 1

16 Writ petition — Even if small fraction of cause of action
accrued within the territories of a State, the High Court of that State will
have jurisdiction

[Rajendran Chingaravelu v. R. K. Mishra, Addl. CIT,(2010) 320
ITR 1 (SC)]

Investigation — When the bona fides of a passenger carrying
an unusually large sum, and his claims regarding the source and legitimacy have
to be verified, some delay and inconvenience is inevitable. The inspection and
investigating officers have to make sure that the money was not intended for any
illegal purpose. In such a situation, the rights of the passenger will have to
yield to public interest. Any bona fide measures taken in public interest, and
to provide public safety or to prevent circulation of black money, cannot be
objected to as interference with the personal liberty or freedom of a citizen.

The appellant, a computer engineer, who was lucratively
employed in the United States of America for more than ten years, returned to
India with his earnings and took up employment in Hyderabad in the year 2006. He
wanted to buy a property at Chennai. But his attempts were not fruitful. He was
advised that if he wanted to buy a good plot, he must be ready to pay
considerable part of the sale price in cash as advance to the prospective
seller. When the appellant ultimately identified a prospective seller, he wanted
to go to Chennai with a large sum and finalise the deal. He contacted the
Reserve Bank of India, ICICI Bank (his banker) and the airport authority to find
out whether he could carry a large sum of money in cash while travelling. He was
informed that there was no prohibition. Thereafter, he drew Rs.65 lakhs from his
bank. He travelled by air from Hyderabad to Chennai on June 15, 2007, carrying
the said cash. At the Hyderabad airport, he disclosed to the security personnel
who checked his baggage that he was carrying cash of Rs.65 lakhs along with a
bank certificate certifying the source and withdrawals. After the contents of
his bags were examined by the security personnel, he was allowed to board the
aircraft without any objection. But when the flight reached Chennai, some police
officers and others (who were later identified as officers of the Income-tax
Investigation Wing) rushed in, and loudly called out the name of the appellant.
When the appellant identified himself, he was virtually pulled from the aircraft
and taken to an office in the first floor of the airport. He was questioned
there about the money he was carrying. The appellant showed them the cash and
the bank certificate evidencing the withdrawals and explained as to how the
amounts formed part of his legitimate declared earnings which were drawn from
his bank’s account. He also explained to them the purpose of carrying such huge
amount. The officers recorded his statement. After a few hours, the second
respondent came in and asked the appellant to sign some papers without allowing
him to read them and without furnishing him copies. It became obvious to the
appellant that the officers of the Income-tax Department were suspecting him of
carrying the money illegally. They even attempted to coerce him to admit that
the amount was being carried by him for some illegal purpose. Having failed,
they seized the entire amount under a mahazar, gave him a receipt and permitted
him to leave. In this process, he was detained for about 15 hours without any
justifiable reason. To add insult to the injury, the Tax Intelligence Officers
prematurely and hurriedly informed the newspapers that they had made a big haul
of Rs.65 lakhs in cash, making it appear as though the appellant was illegally
and clandestinely carrying the said amount, and they had successfully caught him
while he was at it. The next day all three leading Tamil newspapers (Daily
Thanthi, Dinamalar, Dinamani) as also an English daily — The Hindu, prominently
carried the news of the seizure from him. The news reports disclosed his name,
profession, his native place in Tamil Nadu, his place of employment. The news
report also stated that he was not able to satisfactorily explain the source of
the amount and that the officials had found discrepancies between what was drawn
by him from the bank and what he was carrying. Ultimately, two months later,
after completing the investigation and verification, as nothing was found to be
amiss or irregular, the seized money was returned to him, but without any
interest.

The appellant filed a writ petition before the High Court
listing the following four acts on the part of the income-tax officials as
objectionable and violative of his fundamental rights : (i) his illegal
detention for more than 15 hours at the Chennai airport; (ii) illegal seizure of
the cash carried by him despite his explanation about the source and legitimacy
of the funds with supporting documents; (iii) failure to return the seized
amount for more than two months without any justification; and (iv) prematurely
and maliciously disclosing to the media a completely false picture of the
incident. The said acts, according to him, tarnished his reputation among his
friends, relatives and acquaintances, by being dubbed as some sort of a
criminal. The said writ petition was dismissed by the High Court on the ground
that no part of the cause of action arose within Andhra Pradesh.

On appeal, the Supreme Court held that the High Court did not
examine whether any part of cause of action arose in Andhra Pradesh. Clause (2)
of Article 226 makes it clear that the High Court exercising jurisdiction in
relation to the territories within which the cause of action arises wholly or in
part, will have jurisdiction. This would mean that even if a small fraction of
the cause of action (that bundle of facts which gives a petitioner, a right to
sue) accrued within the territories of Andhra Pradesh, the High Court of that
State will have jurisdiction. In this case, the genesis for the entire episode
of search, seizure and detention was the action of the security/intelligence
officials at Hyderabad airport (in Andhra Pradesh), who having inspected the
cash carried by him, alerted their counterparts at the Chennai airport that the
appellant was carrying a huge sum of money, and required to be intercepted and
questioned. A part of the cause of action, therefore, clearly arose in
Hyderabad. The Supreme Court also noticed that the consequential income-tax
proceedings against the appellant, which he challenged in the writ petition,
were also initiated at Hyderabad. Therefore, according to the Supreme Court the
writ petition ought not to have been rejected on the ground of want of
jurisdiction.

Considering the facts of the case, the Supreme Court
requested Mr. Gopal Subramanium, the learned Solicitor General to take notice
and suggest a solution. He agreed to have the matter examined as to whether
there was a need for issue of guidelines. Taking note of the issue, the Central
Board of Direct Taxes, Ministry of Finance issued a Circular dated November 18,
2009, setting out the guidelines to be followed by Air Intelligence Units or
Investigation Units while dealing with air passengers with valuables at the
airports of embarkation or destination, to avoid any undue convenience to them.

The Supreme
Court observed that when the bona fides of a passenger carrying an unusually
large sum, and his claims regarding the source and legitimacy have to be
verified, some delay and inconvenience is inevitable. The inspection and
investigating officers have to make sure that the money was not intended for
any illegal purpose. In such a situation, the rights of the passenger will have
to yield to public interest. Any bona fide measures taken in public interest,
and to provide public safety or to prevent circulation of black money, cannot
be objected to as interference with the personal liberty or freedom of a
citizen. According to the Supreme Court the actions of the officers of the
investigation wing in detaining the appellant for questioning and verification,
and seizing the cash carried by him, were bona fide and in the course of
discharge of their official duties and did not furnish a cause of action for
claiming any compensation.

The Supreme Court however held that the appellant’s grievance in
regard to media being informed about the incident even before completion of
investigation, was justified. The Supreme Court there is a growing tendency
among investigating officers (either police or other departments) to inform the
media, even before the completion of investigation, that they have caught a
criminal or an offender. Such crude attempts to claim credit for imaginary
breakthroughs should be curbed.

The Supreme
Court however was of the view that the bona fides of the intelligence wing
officials at Chennai was not open to question, though their enthusiasm might
have exceeded the limits when they went to press in regard to the seizure.

Nirav Shah

Impounding of documents : Scope of power u/s.131(3) of Income-tax Act, 1961 : Document does not include passport : Passport cannot be impounded u/s.131.

New Page 1

Reported :

25 Impounding of documents : Scope of power u/s.131(3) of
Income-tax Act, 1961 : Document does not include passport : Passport cannot be
impounded u/s.131.

[Avinash Bhosale v. UOI, 322 ITR 381 (Bom.)]

In a writ petition challenging the authority of impounding of
the passport with reference to S. 131(3) of the Income-tax Act, 1961, the Bombay
High Court held as under :

“(i) In Suresh Nanda’s case (2008) 3 SCC 674, the Supreme
Court was dealing with power of a Court to impound a document and, in that
context, held that ‘document’ does not include a passport.

(ii) If by an interpretative process the Supreme Court held
that even a Court cannot impound a passport, then, it would be highly
inappropriate to interpret the term ‘documents’ used in S. 131(3) of the
Income-tax Act, 1961, so as to enable the executive authorities to impound the
passport.

(iii) A passport cannot be impounded u/s.131 of the Act.”

levitra

Nirav Shah

Assessment : Validity : Block period 1-4-1990 to 20-8-2000 : Copies of seized material not provided to assessee, nor assessee given opportunity to cross-examine person whose statement AO relied upon : Fatal to proceedings : Addition cannot be sustained.

New Page 1

Reported :

23 Assessment : Validity : Block period 1-4-1990 to
20-8-2000 : Copies of seized material not provided to assessee, nor assessee
given opportunity to cross-examine person whose statement AO relied upon : Fatal
to proceedings : Addition cannot be sustained.

[CIT v. Ashwani Gupta, 322 ITR 396 (Del.)]

In an appeal against the block assessment order the
Commissioner (Appeals) found that the Assessing Officer had passed the
assessment order in violation of the principles of natural justice inasmuch as
he had neither provided copies of the seized material to the assessee, nor had
he allowed the assessee to cross-examine the person on the basis of whose
statement the addition was made. He therefore held that the entire addition made
by the Assessing Officer was invalid and accordingly deleted the addition. The
Tribunal confirmed the order of the Commissioner (Appeals).

On appeal by the Revenue, the Delhi High Court upheld the
decision of the Tribunal and held as under :

“(i) The Revenue had accepted the findings of the Tribunal
on facts as also the position that there had been a violation of the
principles of natural justice. However, its plea was that the violation of the
principles of natural justice was not fatal so as to jeopardise the entire
proceedings.

(ii) The Tribunal correctly held that once there was a
violation of the principles of natural justice inasmuch as seized material was
not provided to an assessee, nor was cross-examination of the person on whose
statement the Assessing Officer relied upon, granted, such deficiencies would
amount to a denial of opportunity and, consequently, would be fatal to the
proceedings.

(iii) No substantial question of law arose.”

levitra

Nirav Shah

Business expenditure : Expenditure on prospecting, etc. of minerals : Applicability of S. 35E of Income-tax Act, 1961 : A.Y. 2001-02 : Assessee in business of prospecting or exploration of ores and minerals and not in business of mining ores and minerals

New Page 1

Reported :

24 Business expenditure : Expenditure on prospecting, etc. of
minerals : Applicability of S. 35E of Income-tax Act, 1961 : A.Y. 2001-02 :
Assessee in business of prospecting or exploration of ores and minerals and not
in business of mining ores and minerals : No possibility of commercial
production : S. 35E not workable : S. 35E not applicable : Assessee entitled to
deduction of entire expenditure.

[CIT v. ACC Rio Tinto Exploration Ltd., 230 CTR 383
(Del.)]

The assessee company is engaged in the business of
prospecting and exploring ores and minerals. For the A.Y. 2001-02, the Assessing
Officer disallowed the claim for deduction of the expenditure on the ground that
the provisions of S. 35E of the Income-tax Act, 1961 were applicable to the case
of the assessee and that the expenditure will be allowable in the year of
commercial production. The Assessing Officer rejected the contention of the
assessee that the provisions of S. 35E are not applicable since the assessee is
engaged in the business of exploring and prospecting of ores and minerals and
that it was not engaged in commercial production of any mineral. The CIT(A)
found that the activity of exploration constituted a separate activity by itself
as different and distinct from commercial production and allowed the assessee’s
claim. The Tribunal upheld the decision of the CIT(A).

On the appeal filed by the Revenue, the Delhi High Court
upheld the decision of the Tribunal and held as under :

“(i) Upon a plain reading of the provisions of S. 35E, it
is apparent that unless and until there is commercial production, the
provisions of S. 35E(1) would be unworkable. The expression ‘year of
commercial production’ referred to in S. 35E(2) is defined in S. 35E(5)(b).
Unless and until there is actual commercial production, the phrase ‘year of
commercial production’, appearing in S. 35E(2), would be rendered meaningless.

(ii) The Tribunal has, on facts, come to the conclusion
that the assessee-company’s objects did not include mining of ores or minerals
or commercial production, in the sense understood within the meaning of S.
35E. Consequently, the Tribunal agreed with the assessee’s contention that
there would never be commercial production of any mineral or ore as a part of
the activities of the assessee.

(iii) Consequently, the provisions of S. 35E would not be
applicable to the facts and circumstances of the present case as there was no
possibility of any commercial production.”

levitra

Nirav Shah

Revision : S. 197 and S. 264 of Income-tax Act, 1961 : An order rejecting application u/s.197 for lower rate for deduction of tax is an order which can be revised u/s.264.

New Page 1

Unreported

22 Revision : S. 197 and S. 264 of Income-tax Act, 1961 : An
order rejecting application u/s.197 for lower rate for deduction of tax is an
order which can be revised u/s.264.

[Larsen & Toubro Ltd. & Anr. (Bom.), W.P.(L) No. 694
of 2010, dated 28-4-2010]

On 29-10-2009, the petitioner had made an application to the
Assessing Officer u/s.197 of the Income-tax Act, 1961 for issuing a certificate
authorising MMRDA to deduct tax at source at a lower rate of 0.11% from the
payments made by it to the petitioner under a contract. The application was
rejected by the Assessing Officer. The petitioner therefore preferred a revision
petition u/s.264 to the Commissioner. The Commissioner rejected the application
inter alia on the ground that when the Assessing Officer rejects an
application u/s.197, he does not pass an ‘order’ as envisaged in S. 264 and
consequently, a revision u/s.264 is not maintainable.

The Bombay High Court allowed the writ petition filed by the
petitioner challenging the order of the Commissioner and held as under :

“(i) The Commissioner is manifestly in error when he holds
that the rejection of an application u/s.197 by the Assessing Officer does not
result in an order and that the revisional power which is vested in the
Commissioner u/s.264 would not be attracted.

(ii) The Assessing Officer when he rejects an application
is bound to furnish reasons which would demonstrate an application of mind by
him to the circumstances which are mandated both by the statute and by the
Rules to be taken into consideration. Hence, it would be impossible to accept
the view that the rejection of an application u/s.197 does not result in an
order.

(iii) The expression ‘order’ for the purposes of S. 264 has
a wide connotation. The Parliament has used the expression ‘any order’. Hence,
any order passed by an authority subordinate to the Commissioner, other than
an order to which S. 263 applies, is subject to the revisional jurisdiction
u/s.264. A determination of an application u/s.197 requires an order to be
passed by the Assessing Officer after application of mind to the circumstances
which are germane u/s.197 and the rules framed U/ss.2A.

(iv) The Commissioner was, therefore, manifestly in error
when he held that there was no order which would be subject to his revisional
jurisdiction u/s.264.”

Reported :

23 Assessment : Validity : Block period 1-4-1990 to
20-8-2000 : Copies of seized material not provided to assessee, nor assessee
given opportunity to cross-examine person whose statement AO relied upon : Fatal
to proceedings : Addition cannot be sustained.

[CIT v. Ashwani Gupta, 322 ITR 396 (Del.)]

On appeal by the Revenue, the Delhi High Court upheld the
decision of the Tribunal and held as under :

(iii) No substantial question of law arose.”

levitra

Nirav Shah

Reassessment : S. 147, S. 148 and S. 154 of Income-tax Act, 1961 : A.Y. 2004-05 : Reason to believe : Where the AO has option to rectify the assessment order u/s.154, reopening of assessment u/s.147 is not justified.

New Page 1

Unreported

20 Reassessment : S. 147, S. 148 and S. 154 of Income-tax
Act, 1961 : A.Y. 2004-05 : Reason to believe : Where the AO has option to
rectify the assessment order u/s.154, reopening of assessment u/s.147 is not
justified.

[Hindustan Unilever Ltd. v. Dy. CIT (Bom.), W. P. No.
85 of 2009, dated 1-4-2010]

In the case of the petitioner, the assessment for the A.Y.
2004-05 was completed by an order dated 27-12-2006 passed u/s.143(3) of the
Income-tax Act, 1961. Subsequently, the Assessing Officer issued a notice
u/s.148, dated 7-4-2008 for reopening the assessment. Briefly, the reasons given
for reopening the assessment are as under :

“(i) The following deductions have been wrongly allowed in
the assessment order passed u/s. 143(3) of the Act :

(a) Deduction of Rs.10,84,07,449 as loss of plantation
division, being 40% of the loss on sale of tea is wrongly allowed. Rule 8
applies to income and not for loss.

(b) Deduction of Rs.3,07,50,000 u/s.54EC has been
wrongly allowed since the transfer of the asset is on 29-9-2003 and the
date of allotment of the bond is 31-3-2004, which is beyond the prescribed
period of six months.

(c) Loss of Rs.1,33,49,654 of a unit eligible for
deduction u/s.10B has been wrongly allowed to be set off against normal
business income and this has resulted in excessive deduction u/s.10B to
that extent.

(ii) Deduction of loss of Rs.10,84,07,449 from
plantation division has been allowed twice and as such there is
computation error.

The Bombay High Court quashed the notice u/s. 148, dated
7-4-2008 and held as under :

“(i) Loss from plantation division : Rule 8 creates
a legal fiction, as a result of which the income which is derived from the
sale of tea is to be computed as if it is income derived from business. In the
present case, the Assessing Officer, while issuing a notice for re-opening the
assessment, observed that the provisions of Rule 8 are applicable ‘only in the
case of income’ and the claim of the assessee to set off 40% of losses against
normal business profits could not be allowed. On this basis the Assessing
Officer has formed the opinion that the loss of Rs.10.84 crores attributable
to the business activity of the assessee involving the manufacture and sale of
tea was liable to be disallowed. It is on the basis of Rule 8 that the
Assessing Officer seeks to postulate that the loss attributable to the
business activity of the assessee would have to be disregarded on the ground
that it is not allowable expenditure. This inference which is sought to be
drawn by the Assessing Officer is contrary to the plain meaning of the
charging provisions of the Act; and to Rule 8, besides being contrary to the
position in law as laid down by the Supreme Court. The assessee was lawfully
entitled to adjust the loss which arose as a result of the business activity
under Rule 8.

(ii) Deduction u/s.54EC : The assessee transferred
the asset on 29-9-2003. The period of six months was due to expire on
28-3-2004. The assessee invested an amount of Rs.3.07 crores on 19-3-2004. A
receipt was issued on that date by the National Housing Bank. A debit was
reflected in the bank account of the assessee to the extent of the sum
invested on 19-3-2004. The certificate of bond was issued by the National
Housing Bank on 9-6-2004, which refers to the date of allotment as 31-3-2004.
For the purpose of the provisions of S. 54EC, the date of the investment by
the assessee must be regarded as the date on which the payment was made and
received by the National Housing Bank. This was within a period of six months
from the date of the transfer of the asset. Consequently the provisions of S.
54EC were complied with by the assessee. There is absolutely no basis in the
ground for re-opening the assessment.

(iii) Loss incurred by eligible unit u/s.10B : While
re-opening the assessment, the Assessing Officer has proceeded on the basis
that S. 10B provides an exemption and that in respect of the Crab Stick Unit
the assessee had suffered a loss of Rs.1.33 crores. The Assessing Officer has
observed that since the income of the unit was exempt from taxation, the loss
of the unit could not have been set off against the normal business income.
However this was allowed by the assessment order and it is opined that the
assessee’s income to the extent of Rs.1.33 crores has escaped assessment. The
Assessing Officer while re-opening the assessment ex-facie proceeded on
the erroneous premise that S. 10B is a provision in the nature of an
exemption. Plainly, S. 10B as it stands is not a provision in the nature of an
exemption, but provides for a deduction. The provision as it earlier stood was
in the nature of an exemption. After the substitution of S. 10B by the Finance
Act, 2000, the provision as it now stands provides for a deduction.
Consequently, it is evident that the basis on which the assessment has sought
to be re-opened is belied by a plain reading of the provision. The Assessing
Officer was plainly in error in proceeding on the basis that because the
income is exempted, the loss was not allowable. All the four units of the
assessee were eligible u/s.10B. Three units had returned a profit, while the
Crab Stick Unit had returned a loss. The assessee was entitled to a deduction
in respect of the profits of the three eligible units, while the loss
sustained by the fourth unit could be set off against the normal business
income. In the circumstances, the basis on which the assessment is sought to
be re-opened is contrary to the plain language of S. 10B.

(iv) Computational error : The other ground on which
the assessment is sought to be re-opened is the computational error in the
assessment order resulting in the deduction of the loss from plantation
division of Rs. 10.84 crores twice. There can be no dispute about the position
that the computational error that has been made by the Assessing Officer in
the present case is capable of being rectified u/s.154(1). Where the power to
rectify an order of assessment u/s.154(1) is adequate to meet a mistake or
error in the order of assessment, the Assessing Officer must take recourse to
that power as opposed to the wider power to re-open the assessment. The
assessee cannot be penalised for a fault of the Assessing Officer. The
provisions of the statute lay down overlapping remedies which are available to
the Revenue, but the exercise of these remedies must be commensurate with the
purpose that is sought to be achieved by the Legislature. The re-opening of an
assessment u/s.147 has serious remifications. Therefore, before recourse can
be taken to the wider power to reopen the assessment on the ground that there
is a computation error, as in the present case, the Assessing Officer ought to
have rectified the mistake by adopting the remedy available u/s.154 of the
Act.

All statutory powers have to be exercised
reasonably. Where a statute confers an area of discretion, the exercise of that
discretion is structured by the requirement that discretionary powers must be
exercised reasonably. The remedies which the law provides are tailored to be
proportional to the situation which the remedy resolves. Where the statute
provides for several remedies, the choice of the remedy must be appropriate to
the underlying basis and object of the conferment of the remedy. A simple
computational error can be resolved by rectifying an order of assessment
u/s.154(1). It would be entirely arbitrary for the Assessing Officer to reopen
the entire assessment u/s.147 to rectify an error or mistake which can be
rectified u/s.154. An arbitrary exercise of power is certainly not a
consequence which the Parliament contemplates. We, therefore, hold that in this
case the Revenue has an efficacious remedy open to it in the form of a
rectification u/s.154 for correcting the computational error and that
consequently recourse to the provisions of S. 147 was not warranted.

For all the aforesaid
reasons, we are of the view that the Assessing Officer could not possibly have
formed a belief that the income chargeable to tax had escaped assessment within
the meaning of S. 147.”

Nirav Shah

Recovery of tax : Company : Directors liability u/s.179 of Income-tax Act, 1961 : A.Y. 1990-91 : Liability does not extend to penalty payable by the company.

New Page 1

Unreported

21 Recovery of tax : Company : Directors liability u/s.179 of
Income-tax Act, 1961 : A.Y. 1990-91 : Liability does not extend to penalty
payable by the company.

[Dinesh T. Tailor v. TRO (Bom.), W.P. No. 641 of 2010,
dated 27-4-2010]

The petitioner was a director of a company called Yazad
Investment & Finance Pvt. Ltd. up to 14-10-1989. By an order u/s.179 of the
Income-tax Act, 1961 the Assessing Officer raised a demand of Rs. 12.74 lakhs
against the petitioner, which is the liability of the said company for the A.Y.
1990-91 by way of tax and also the penalty u/s.271(1)(c) payable by the company.

On a writ petition filed by the petitioner challenging the
said order, the Bombay High Court set aside the said order u/s.179 for
reconsideration and also held that the liability of a director u/s.179 does not
extend to the penal liability payable by the company. The High Court held as
under :

“(i) S. 179(1) refers to ‘any tax due from a private
company’ and every director of the company is jointly and severally liable for
the payment of ‘such tax’, which cannot be recovered from the company. The
expression ‘tax due’ and, for that matter the expression ‘such tax’ must mean
tax as defined for the purposes of the Act by S. 2(43).

(ii) ‘Tax due’ will not comprehend within its ambit a
penalty.”

levitra

Nirav Shah

MAT credit : Interest u/s.234B of Income-tax Act, 1961 : A.Y. 2000-01 : Credit for brought forward MAT is to be given from gross demand before charging interest u/s.234B.

New Page 1

Unreported

19 MAT credit : Interest u/s.234B of Income-tax Act, 1961 :
A.Y. 2000-01 : Credit for brought forward MAT is to be given from gross demand
before charging interest u/s.234B.

[CIT v. Apar Industries Ltd. (Bom.), ITA No. 1036 of
2009, dated 6-4-2010]

In an appeal filed by the Revenue for the A.Y. 2000-01, the
following question was raised before the Bombay High Court :

“Whether on the facts and in the circumstances of the case,
the Tribunal erred in law in holding that credit for brought forward MAT is to
be given from gross demand before charging interest u/s.234B of the Income-tax
Act, 1961 ?”

Following the judgment of the Delhi High Court in CIT v.
Jindal Exports Ltd., 314 ITR 137 (Del.), the Bombay High Court upheld the
decision of the Tribunal and held as under :

“(i) The sum represented by the available MAT credit would
fall within the expression ‘tax . . . . already paid under any provision of
this Act’ in S. 140A(1).

(ii) The expression tax paid ‘otherwise’ in S. 234B(2)
would take within its sweep any tax paid under a provision of the Act,
including the MAT credit.

(iii) The amendment to Explanation (1) of S. 234B by the
Finance Act, 2006 is clarificatory.

(iv) Credit for brought forward MAT is to be given from
gross demand before charging interest u/s.234B.”

levitra

Nirav Shah

Industrial undertaking : Deduction u/s.80IB of Income-tax Act, 1961 : A.Y. 2000-01 : Interest on delayed payment of sale price is part of sale price : It is derived from the industrial undertaking : Is eligible for deduction u/s.80IB.

New Page 1

Unreported

18 Industrial undertaking : Deduction u/s.80IB of Income-tax
Act, 1961 : A.Y. 2000-01 : Interest on delayed payment of sale price is part of
sale price : It is derived from the industrial undertaking : Is eligible for
deduction u/s.80IB.

[CIT v. Vidyut Corporation (Bom.), ITA(L) No. 2865 of
2009, dated 21-4-2010]

The assessee was engaged in manufacturing electrical fittings
and appliances and was eligible for the deduction u/s.80IB of the Income-tax
Act, 1961. The assessee sells its manufactured products mainly to M/s. Bajaj
Electricals Ltd. Payment is normally made on delivery of goods. In case of delay
the assessee also receives interest for delayed payment. For the A.Y. 2000-01
the Assessing Officer disallowed the claim for deduction u/s.80IB in respect of
interest for delayed payment. The Commissioner and the Tribunal allowed the
assessee’s claim.

On appeal by the Revenue, the Bombay High Court upheld the
decision of the Tribunal and held as under :

“(i) What is received by the assessee from the purchaser is
a component of interest towards delayed payment of the price of the goods
sold, supplied and delivered by the assessee. There can be no dispute about
the position that the price realised by the assessee from the sale of goods
manufactured by the industrial undertaking constitutes a component of the
profits and gains derived from the eligible business. The purchaser, on
account of delay in payment of the sale price also pays to the assessee
interest. This forms a component of the sale price and is paid towards the lag
which has occurred in the payment of the price of the goods sold by the
assessee.

(ii) On these facts, therefore, the payment of interest on
account of the delay in payment of the sale price of the goods supplied by the
undertaking partakes the same nature and character as the sale consideration.
The delayed payment charges consequently satisfy, together with the sale
price, the first degree test which has been laid down by the Supreme Court in
Liberty India v. CIT, 317 ITR 218.”

levitra

Nirav Shah

Search and Seizure : Ss. 10(22) and 132(5) of I. T. Act, 1961 : A. Ys. 1984-85 to 1990-91 : Summary assessment u/s. 132(5) : Assessee claiming exemption u/s. 10(22) : Prima facie correctness of claim has to be considered.

New Page 1

Search and Seizure : Ss. 10(22) and 132(5) of I. T. Act,
1961 : A. Ys. 1984-85 to 1990-91 : Summary assessment u/s. 132(5) : Assessee
claiming exemption u/s. 10(22) : Prima facie correctness of claim has to be
considered.

[Anjum Hami-E-Islam vs. CIT; 310 ITR 37 (Bom)]

Petitioner Trust was running 12 educational institutions and was entitled to exemption u/s. 10(22) of the Income-tax Act, 1961. In February 1991 search proceedings were carried out in the premises of the Petitioner Trust and fixed deposits worth Rs. 93 lakhs were seized and an order u/s. 132(5) was passed determining the tax liability without considering the exemption allowable u/s. 10(22) of the Act. The Commissioner also rejected the application u/s. 132(11) without considering the claim for exemption u/s. 10(22) of the Act.

On a writ petition filed by the Petitioner challenging the order, the Bombay High Court held as under :

“i) When a public trust like the petitioner which ran a number of educational institutions had claimed exemption in view of the provisions of section 10(22) of the Act, the Officer passing orders u/s. 132(5) had to find out at least prima facie as to why and how such trust was not entitled to exemption.

ii) The order to the extent that he refused to consider the plea of the petitioner for exemption u/s. 10(22) of the Act was liable to be quashed”.

Nirav Shah

Return : Defect in return : Ss. 139(9) and 292B of I. T. Act, 1961 : Failure by assessee to sign and verify return : Defect could not be cured : Return invalid : Consequent assessment invalid : Tribun

New Page 1

Return : Defect in return : Ss. 139(9) and 292B of I. T.
Act, 1961 : Failure by assessee to sign and verify return : Defect could not
be cured : Return invalid : Consequent assessment invalid : Tribun

[CIT vs. Harjinder Kaur; 310 ITR 71 (P&H)].

The return filed by the assessee was neither signed by the
assessee nor verified by the assessee. The Tribunal held that the return of
income was not valid and therefore, the consequent assessment order is also
invalid.

On appeal by the Revenue, the Punjab and Haryana High Court
upheld the decision of the Tribunal and held as under :

“i) The provisions of section 292b of the Income-tax Act,
1961, do not authorise the Assessing Officer to ignore a defect of a
substantive nature and therefore, the provision categorically records that a
return would not be treated as invalid, if the same “in substance and effect
is in conformity with or according to the intent and purpose of this Act”.

ii) The return did not bear the signature of the assessee
and had not also been verified by her. Hence, the return was an absolutely
invalid return as it had a glaring inherent defect which could not be cured
in spite of the deeming effect of section 292B”.

levitra

Nirav Shah

Reference to Valuation Officer : S. 55A of I. T. Act, 1961 : A. Y. 1996-97 : Reference to Valuation Officer can be made only after AO records opinion that the value had been underestimated by the assessee: Reference before filing of return by assessee : N

New Page 1

Reference to Valuation Officer : S. 55A of I. T. Act,
1961 : A. Y. 1996-97 : Reference to Valuation Officer can be made only after
AO records opinion that the value had been underestimated by the assessee:
Reference before filing of return by assessee : Not valid.

[Hiaben Jayantilal Shah vs. ITO; 310 ITR 31 (Guj)].

For the A. Y. 1996-97, the petitioner assessee had filed
the return of income on 27.08.1996. The assessee had computed capital gain by
adopting the market value of the asset as on 01.04.1981, determined by the
registered valuer to be the cost of acquisition by exercising option u/s.
55(2) of the Income-tax Act, 1961. The assesee received a notice from the
Valuation Officer informing that a reference was made by the Assessing Officer
on 26/04/1996 u/s. 55A of the Act.

On a writ petition filed by the assessee challenging the
reference, the Gujarat High Court held as under :

“i) Clause (b) of section 55A of the Income-tax Act,
1961, can be invoked only when the value of the asset claimed by the
assessee is not supported by the valuation report of a registered valuer.
For invoking section 55A of the Act, there has to be a claim made by the
assessee, before the Assessing Officer can record his opinion either under
clause (a) or clause (b) of section 55A of the Act to make a reference to
the Valuation Officer.

ii) In so far as the fair market value of the property as
on 01/04/1981, was concerned, the petitioner had claimed it at a sum of
Rs.6,25,000 as per the registered valuer’s report. Therefore, the Assessing
Officer was required to form an opinion that the value so claimed was less
than the fair market value. The estimated value proposed by the Valuation
Officer was shown at Rs.3,97,000 which was less than the fair market value
shown by the assessee. Therefore, clause (a) of section 55A of the Act could
not be made applicable.

iii) Clause (b) of section 55A of the Act can be invoked
only in any other case, namely, when the value of the asset claimed by the
assessee was not supported by an estimate by a registered valuer. In the
facts of the present case, clause (b) of section 55A of the Act also could
not be invoked.

iv) The reference was made on 26/04/1996, whereas the
return of income had been filed by the assessee only on 27/08/1996. Hence on
the date of making the reference by the Assessing Officer, no claim was made
by the assessee and the Assessing Officer could not have formed any opinion
as to the existence of prescribed difference between the value of the asset
as claimed by the assessee and the fair market value. Therefore also, the
provisions of section 55A of the Act, could not be resorted to.

v) The only ground on which reference was made to the
Valuation Officer was that the value declared by the assessee as on the date
of the execution and registration of the sale deed was lower by more than
25%. There was no provision in the Act which permits the Assessing Officer
to disturb the sale consideration, at least section 55A of the Act could not
be invoked for the said purpose.

vi) The reference to the valuation officer was not
valid”.

levitra

Nirav Shah

Business expenditure : Disallowance u/s. 40A(2) of I. T. Act, 1961 : A. Ys. 1991-92 and 1992-93: Incentive commission paid to sister concern : Sister concern paying tax at a higher rate : Not a case of evasion of tax: Deduction to be allowed.

New Page 1

Business expenditure : Disallowance u/s. 40A(2) of I. T.
Act, 1961 : A. Ys. 1991-92 and 1992-93: Incentive commission paid to sister
concern : Sister concern paying tax at a higher rate : Not a case of evasion
of tax: Deduction to be allowed.

[CIT vs. Indo Saudi Services (Travel) P. Ltd., 310
ITR 306 (Bom)].

The assessee was a general sales agent of a foreign airline
S. For the A. Ys. 1991-92 and 1992-93 the Assessing Officer found that the
incentive commission paid by the assessee to the sister concern was half
percent more than that paid to other sub-agents. Relying on the provisions of
section 40A(2) of the Income-tax Act, 1961, the Assessing Officer disallowed
the excess commission paid to the sister concern at the rate of half percent.
The Tribunal deleted the additions.

On appeal by the Revenue, the Bombay High Court upheld the
decision of the Tribunal and held as under :

“i) Under the CBDT Circular No. 6-P, dated 06/07/1968, it
is stated that no disallowance is to be made u/s. 40A(2) in respect of the
payments made to the relatives and sister concerns where there is no attempt
to evade tax.

ii) The learned Advocate appearing for the appellant was
not in a position to point out how the assessee evaded payment of tax by the
alleged payment of higher commission to its sister concern since the sister
concern was also paying tax at higher rate and copies of the assessment
orders of the sister concern were taken on record by the Tribunal.

iii) In view of the aforesaid admitted facts we are of
the view that the Tribunal was correct in coming to the conclusion that the
Commissioner of Income-tax (Appeals) was wrong in disallowing half percent
commission to the sister concern”.

levitra

Nirav Shah

Appeal to Appellate Tribunal : Fees : S. 253(6) of I. T. Act 1961 : Appeal against levy of penalty : Appeal fees is Rs.500 and not based on income assessed : Tribunal calling for fees based on income assessed : Not proper.

New Page 1

Reported :

Appeal to Appellate Tribunal : Fees : S. 253(6) of I. T.
Act 1961 : Appeal against levy of penalty : Appeal fees is Rs.500 and not
based on income assessed : Tribunal calling for fees based on income assessed
: Not proper.

[Dr. Ajit Kumar Pandey vs. ITAT; 310 ITR 195 (Pat)].

In respect of an appeal filed by the assessee before the
Tribunal, against levy of penalty u/s. 271 of the Income-tax Act, 1961, the
assessee had paid Rs.500 as appeal fees. The appeal was decided ex parte.
The assessee applied for restoration of the ex parte order. The
Tribunal agreed to recall the ex parte order and to decide the appeal
on merits provided the assessee furnished the deficit court fee of Rs.8,330.

The assessee challenged the order by filing a writ
petition. The Patna High Court allowed the writ petition and held as under :

“i) In the case of an appeal where the total income of
the assessee is ascertainable from the appeal itself, i.e. when the
appellant was seeking to challenge the assessment of his total income, fees
as mentioned in clauses (a), (b) and (c) would be required to be paid.

ii) Clause (d) deals with other appeals. Imposition of
penalty u/s. 271 of the Act had no connection or bearing with the total
income of the assessee. If a person aggrieved by an order imposing penalty,
approaches the Tribunal by preferring an appeal, imposition of penalty
having no nexus with the total income of the assessee, it would not be
discernible what is the total income of the appellant and accordingly such
an appeal would be covered by clause (d).

iii) The important words used in clauses (a), (b) and (c)
of sub-section (6) of section 253 are ‘total income of the assessee’.
Therefore that may not be discernible.

iv) The order of the Tribunal was liable to be set aside
and the appeal was remitted for decision on merits.”

levitra

Nirav Shah

Business expenditure : Deduction u/s. 37(1) of I. T. Act, 1961 : A. Y. 2000-01 : Provision for liability is deductible if there is an element of certainty that it shall be incurred : Provision for ‘long service award’ is allowable as deduction.

New Page 1

Reported :

Business expenditure : Deduction u/s. 37(1) of I. T.
Act, 1961 : A. Y. 2000-01 : Provision for liability is deductible if there is
an element of certainty that it shall be incurred : Provision for ‘long
service award’ is allowable as deduction.

[CIT vs. Insilco Ltd.; 179 Taxman 55 (Del)].

The assessee company had evolved a scheme whereby,
employees who rendered long period of service to the assessee, were made
entitled to monetary awards at various stages of their employment equivalent
to a defined period of time. On the basis of actuarial calculation the
assessee made provision for ‘long service award’ payable to its employees
under the scheme and claimed deduction of the same. The Assessing Officer
disallowed the claim on the ground that the grant of award was at the
discretion of the management and therefore, it could not be said to be a
provision towards ascertained liability. The Tribunal allowed the assessee’s
claim.

On appeal by Revenue, the Delhi High Court upheld the
decision of the Tribunal and held as under :

“i) There was no merit in the submission of the revenue
that the liability of the assessee under the long service award scheme was
contingent as the payment under the said scheme was dependent on the
discretion of the management. It is well-settled that if the liability
arises within the accounting period, the deduction should be allowed though
it may be quantified and discharged at a future date. Therefore, the
provision for a liability is amenable to a deduction, if there is an element
of certainty that it shall be incurred and it is possible to estimate
liability with reasonable certainty even though actual quantification may
not be possible, such a liability is not of a contingent nature.

ii) In the instant case, since the provision for ‘long
service award’ was estimated based on actuarial calculations, the deduction
claimed by the assessee had to be allowed.”

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Nirav Shah

Collection of tax at source : S. 206C of I. T. Act, 1961 : Tax not collected by petitioner during period of stay by High Court : No failure to collect : No liability to pay u/s. 206C(6).

New Page 1

Unreported :

Collection of tax at source :
S. 206C of I. T. Act, 1961 : Tax not collected by petitioner during period of
stay by High Court : No failure to collect : No liability to pay u/s. 206C(6).

[The Satpuda Tapi Parisar Sahakari Sakhar Karkhana Ltd.
vs. CIT (Bom); W. P. No. 3357 of 1996; Dated 13/04/2009.].

The petitioner is a co-operative sugar factory and is a
manufacturer of country liquor. When the provisions of section 206C of the
Income-tax Act, 1961 were made applicable to the sale of country liquor, the
purchasers of country liquor challenged the provision by filing writ
petitions. The High Court granted stay of the operation of the provision and
the petitioner was directed by the High Court not to collect tax u/s. 206C in
respect of the sale of country liquor to such purchasers. Subse-quently, the
stay was vacated by the High Court. In respect of such cases the petitioner
did not collect tax on such sales only during the period of stay. For the
remaining period and in all other cases the petitioner had collected tax and
had deposited it in the treasury. After the stay was vacated the ITO Nashik
held that during the period of stay the petitioner was required to collect tax
at source of Rs.25,40,738. He therefore held that the petitioner is liable to
pay the said amount u/s. 206C(6) in spite of the fact that the petitioner had
not collected the amount in view of the stay order passed by the High Court.
Accordingly, he raised a demand of Rs.25,40,738 u/s. 206C(6) of the Act. The
Commis-sioner of Income-tax dismissed the revision petition.

The Bombay High Court allowed the writ petition challenging
the said order and the demand and held as under :

“i) The short question that we are called upon to
consider is whether considering the interim relief granted by this Court
whereby the petitioner herein was restrained from collecting the tax from
the purchasers, would invite the provisions of section 206C of the Act.

ii) U/s. 206C(1) every person, being a seller, had to
collect from the buyer of any goods of the nature specified in clause (2) of
the Table a sum equal to a percentage specified in the said Table. Under
sub-section (6) of section 206C any person responsible for collecting tax in
accordance with the provisions of this section shall, notwithstanding such
failure, be liable to pay the tax to the credit of the Central Government in
accordance with the provisions of sub-section (3). Sub-section (3) of
section 206C sets out that any person collecting any amount has to credit
the same to the credit of the Central Government as prescribed.

iii) On an order passed by this Court restraining the
petitioner from collecting the tax for the period, from the date of stay
till its vacation, is the petitioner liable pursuant to the provisions of
section 206C(6) ? The language used is any person responsible for collecting
the tax and who fails to collect the tax. It is true that the petitioner
being a seller is normally responsible. However, does it amount to ‘failure
to collect’ when he was restrained from collecting the tax ? Would he then
be responsible to collect the tax ? In the instant case admittedly
considering the language of the interim relief itself the petitioner who
otherwise was responsible for collecting the tax was prevented from
collecting the tax. Once the petitioner was prevented from collecting the
tax, it cannot be said that he was ‘a person responsible for collecting the
tax’. The responsibility would have arisen if he could collect the tax. The
expression ‘responsible’, therefore, has to be read in the context of
statutory duty to collect which the petitioner was bound to perform by
virtue of the provisions.

iv) The order of the Court would be binding and had to be
complied with. The issue of collection would arise at the point of sale. The
interim order was a blanket order of restriction from collecting. The
question of the petitioner, therefore, collecting the tax and therefore,
being responsible would not arise. There was bar on him to collect the tax.
If he could not collect the tax at the point of time of order, the question
of he depositing the sum u/ss. (3) or (6) of section 206C would not arise
till such period the disability disappeared. Alterna-tively on account of
the interim relief it cannot be said to be ‘failure to collect’. Failure
would contemplate an act of omission on the part of the party. The party was
aware that he had to collect the tax. This Court however, at the instance of
the buyer restrained him from collecting the tax.

v) In the instant case the disability disappeared on the
stay being vacated by this Court. Thus for the period when the stay was in
operation, as the petitioner was prevented from collecting the tax it cannot
be said that he would be liable under sub-section (6) of section 206C. A
duty was cast on the petitioner by operation of law. Petitioner could not
discharge that duty by virtue of an order of this Court. The question,
therefore, of calling on him to pay the amount which he was disabled to
collect would be illegal. If the petitioner had collected the tax it would
have been in contempt of this Court. We are, therefore, clearly of the
opinion that even though it can be said that considering the provisions of
section 206C a duty had been cast on persons like the petitioner to collect
the tax, by virtue of the interim relief he could not collect the tax for
the relevant period. Section 206C would, therefore, not be attracted.”

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Nirav Shah

Settlement of cases : Abatement of proceedings : Constitutional validity : By way of interim relief Settlement Commission directed not to consider application of assessee having abated u/s.245HA for want of compliance with S. 245D(2D) as amended by the Fi

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27 Settlement of cases : Abatement of
proceedings : S. 245D(2D) and S. 245HA of Income-tax Act, 1961 : Constitutional
validity : By way of interim relief, Setlement Commission directed not to
consider the application of the assessee having abated u/s.245HA for want of
compliance with S. 245D(2D) as amended by the Finance Act, 2007.

[Sunita Textiles Ltd v. CIT & Ors., 216 CTR 74 (Bom.)]

The constitutional validity of S. 245D(2D) and S. 245HA as
amended by the Finance Act, 2007 was
challenged by filing writ petition. The Bombay High
Court admitted the writ petition and granted interim relief directing the
Settlement Commission not to consider the settlement application filed by the
petitioner having abated u/s.245HA for want of compliance with S. 245D(2D) of
the Income-tax Act, 1961.

On appeal by the Revenue, the Madras High Court upheld
the decision of the Tribunal and held as under :

“(i) There is no dispute that the earlier CIT(A)’s
order has become final and also the AO passed the consequent orders in
giving effect to the said CIT(A)’s order. There was no further appeals by
the Revenue. Though the said CIT(A)’s order is erroneous in view of the
Supreme Court judgment in the case of CIT v. Venkateshwara Hatcheries
(P) Ltd., 237 ITR 174 (SC), the same has not been set aside by the
process known to law.

(ii) The Tribunal is correct in holding that the
Assessing Officer has no jurisdiction to reopen the assessment u/s.147.
Unless and until the said order is set aside by the process known to law,
the said order is valid in law, as well as it binds on the lower
authorities. Hence, the Assessing Officer is not entitled to circumvent
the earlier order passed by the CIT(A) which had become final. Under such
circumstances, the Assessing Officer should not reopen the assessment and
seek to adjudicate on the issue which was already adjudicated by the
Appellate authority.

(iii) The Tribunal correctly decided the matter and the
reasons given by the Tribunal are based on valid materials and evidence,
and there is no error or legal infirmity in the order of the Tribunal so
as to warrant interference.”

Nirav Shah

Valuation of stock : Revenue to prove valuation incorrect : Cannot rely on statement by assessee to its bank

New Page 1

28 Valuation of stock : Rejection of
valuation : Burden on Revenue to prove valuation incorrect : Revenue
cannot rely on statement by assessee to its bank : A.Y. 1991-92.

[CIT v. Acrow India Ltd., 298 ITR 447 (Bom.)]

For the A.Y. 1991-92, the Assessing Officer made an
addition of Rs.17,79,248 by revaluing the closing stock relying on the
statement given by the assessee to its bank. The Tribunal deleted the
addition.

The Bombay High Court dismissed the appeal filed by
the Revenue and held as under :

“(i) As far as this aspect is concerned, the
statement given by the respondent-assessee to the bank is sought to be
relied on by the Revenue. As far as that aspect is concerned, the
Tribunal has clearly held that the valuation of the stock declared to
the bank is in fact inflated and that the correct valuation of the stock
was not suppressed from the Revenue.

(ii) The Tribunal has relied on the judgment of the
Madras High Court in the case of CIT v. N. Swamy, (2000) 241 ITR
363. There the Division Bench has held that the burden of proof in such
a case is on the Revenue and the same could not be discharged by merely
referring to a statement of the assessee to a third party.

(iii) In our view, there is no reason to interfere
with the decision of the Tribunal, inasmuch as it has followed the
decision of the Division Bench of this Court and the Madras High Court.”

Nirav Shah

S. 147 : CIT(A) allowed deductions u/s.80HH and u/s.80I : Reopening of assessment by AO on basis of subsequent Supreme Court decision is not valid

New Page 1

26 Reassessment : S. 147 of Income-tax
Act, 1961 : A.Ys. 1992-93 and 1993-94 : CIT(A) allowed deductions u/s.80HH
and u/s. 80I : Reopening of assessment by AO on the basis of subsequent
Supreme Court decision is not valid.

[CIT v. Ramachandra Hatcheries, 215 CTR 370
(Mad.)]

For the A.Ys. 1992-93 and 1993-94, the assessee’s claim
for deduction u/s.80HH and u/s.80I was disallowed by the Assessing Officer.
In appeal the CIT(A) allowed the claim. The Assessing Officer gave effect to
the order of the CIT(A) and allowed the claim. Subsequently, the Assessing
Officer reopened the assessment for disallowing the claim relying on the
subsequent judgment of the Supreme Court in the case of CIT v.
Venkateshwara Hatcheries (P) Ltd., 237 ITR 174 (SC). The Tribunal held
that the reopening of the assessment was not valid.

On appeal by the Revenue, the Madras High Court upheld
the decision of the Tribunal and held as under :

Nirav Shah

Cash credit : S. 68 : Long-term capital gain : Transaction of shares : Addition treating transaction bogus : Addition not valid in absence of cogent material

New Page 1

24 Cash credit : S. 68 of Income-tax Act,
1961 : Long-term capital gain : Transaction of sale of shares : Addition
treating transaction bogus : Addition not valid in the absence of cogent
material.

[CIT v. Anupam Kapoor, 299 ITR 179 (P&H)]

The assessment in this case was completed u/s. 143(3) read
with S. 147 of the Income-tax Act, 1961. The said assessment was reopened on
receipt of the intimation from the DDIT (Investigation), Gurgaon, stating that
the long-term capital gain on sale of shares declared by the assessee was false
and the transaction was not genuine. In the course of reassessment proceedings,
the assessee furnished evidence in support of the claim of long-term capital
gain. The AO made an addition of Rs.1,74,552, being the consideration on sale of
shares, as unexplained cash credit. The Commissioner (Appeals) deleted the
addition, holding that the AO had not discharged his onus and there was no
material or evidence with the AO to come to the conclusion that the transaction
shown by the assessee was a bogus transaction. The Commissioner (Appeals) took
the view that if a company was not available at the given address, it could not
conclusively prove that the company was non-existent. The Tribunal upheld the
decision of the Commissioner (Appeals) and held that the purchase contract note,
contract note for sales, distinctive numbers of shares purchased and sold, copy
of the share certificates and the quotation of shares on the date of purchase
and the sale were sufficient material to show that the transaction was not
bogus, but a genuine transaction.

On appeal by the Revenue, the Punjab and Haryana High Court
upheld the decision of the Tribunal and held as under :

“(i) There was no material before the AO, which could have
led to a conclusion that the transaction was a device to camouflage activities
to defraud the Revenue. No such presumption could be drawn by the AO merely on
surmises or conjectures.

(ii) The Tribunal took into consideration that it was only
on the basis of a presumption that the AO concluded that the assessee had paid
cash and purchased the shares. In the absence of any cogent material in this
regard, having been placed on record, the AO could not have reopened the
assessment.

(iii) The assessee had made an investment in a company,
evidence whereof was with the AO. Therefore, the AO could not have added the
income, which was rightly deleted by the Commissioner (Appeals) as well as the
Tribunal.”

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Nirav Shah

Dividend income : Deduction u/s.80M : Distribution of interim dividend before due date insufficient compliance of requirement.

New Page 1

25 Dividend income : Deduction u/s.80M of
Income-tax Act, 1961 : A.Y. 1997-98 : Distribution of dividend before due
date : Distribution of interim dividend before due date is in sufficient
compliance of the requirement.

[CIT v. Saumya Finance & Leasing Co. (P) Ltd., 215
CTR 359 (Bom.)]

For the A.Y. 1996-97, the assessee company had filed return
of income including dividend income of Rs.2,69,16,774 and had claimed a
deduction of Rs.2,19,97,105 u/s.80M of the Income-tax Act, 1961 on the basis
of the distribution of interim dividend of Rs.2,19,97,105 before the due date
for filing the return. The Assessing Officer disallowed the claim on the
ground that the condition of distribution of dividend before due date is not
satisfied. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, it was contended on behalf of the
Revenue that the interim dividend was declared by the assessee company in the
financial year 1997-98 and out of income accrued in the said year. It was
further contended that the dividend declared and paid in the subsequent year
could not be a permitted deduction from the income in a previous year, since
the said dividend was paid out of income accruing in the subsequent year.

The Bombay High Court upheld the decision of the Tribunal
and held as under :

“(i) On the bare reading of S. 80M it is clear that the
deduction as permitted is of an amount equal to so much of the amount of
income by way of dividend declared by the company as does not exceed the
amount of dividend distributed by the assessee on or before the due date. S.
80M does not provide for the nature of the dividend distributed by the
assessee company. It does not state that the nature of the dividend
distributed must be for the financial year under assessment.

(ii) Accepting the argument of the Revenue will amount to
laying down an additional restriction to the effect that the dividend
distributed by the assessee company must be for the financial year under
assessment. Laying down such restricting qualification will amount to doing
violence to the plain and clear meaning of the words as contained in S. 80M.

(iii) This is not a case where a literal construction to
be given to S. 80M would lead to an absurd result. The intention of the
Legislature while enacting S. 80M was clearly to ensure that the dividend
income received by the assessee company should be permitted as a deduction
only if it is redistributed as dividend income to its shareholders. The
section provided that the said distribution is to be made before the due
date of the filing of the returns. This has been done by the present
respondent and all the requirements of S. 80M are clearly met by them.”

Nirav Shah

Cash credit : S. 68 : Gift from NRI : Copy of deed and affidavit filed : In absence of anything to show that transaction was by way of money laundering, addition cannot be made u/s.68 : Absence of blood relationship is not relevant

New Page 1

23 Cash credit : S. 68 of Income-tax
Act, 1961 : Gift from NRI : Copy of gift deed and affidavit of NRI donor
filed : In the absence of anything to show that the transaction was by way
of money laundering, addition can-not be made u/s.68 : Absence of blood
relationship or close relationship between the donor and the donee is not
relevant.

[CIT v. Padam Singh Chouhan, 215 CTR 303 (Raj.)]

The Revenue had preferred an appeal against the decision
of the Tribunal, deleting the addition made by the Assessing Officer u/s.68
of the Income-tax Act, 1961. The following question was raised in the
appeal :

“Whether in the facts and the circumstances of the
case, the learned Tribunal was justified in deleting the addition of
Rs.4,50,000, Rs.2,50,000 and Rs.2,00,000, which have been received on
account of gift when no relation has been established from whom gifts have
been received, whether the finding of the learned Tribunal is perverse ?”

The Rajasthan High Court decided the question in favour
of the assessee, dismissed the appeal and held as under :

“(i) There is no legal basis to assume that to
recognise the gift to be genuine, there should be any blood relationship,
or any close relationship between the donor and the donee. Instances are
not rare, when even strangers make gifts, out of very many considerations,
including arising out of love, affection and sentiments. When the assessee
has produced the copies of the gift deeds and the affidavits of the
donors, in the absence of anything to show that the act of the assessee in
claiming gift was an act by way of money laundering, simply because he
happens to receive gifts, it cannot be said that that is required to be
added in his income.

(ii) The Assessing Officer has assumed doubts against
the donor, merely on the basis of his having deposited certain amounts in
his accounts soon before making the gifts, and that the assessee had
withdrawn the amounts deposited by him, including the amount of the said
gifts in a short span of time. With this, the AO has found, that the facts
created doubts, that how the assessee as well as his family members are
receiving such huge gifts from a person residing abroad, and concluded
that it appears that the gifts are not genuine, and only a managed affair
of the assessee.

(iii) The CIT(A) has reversed his findings by holding
that the assessee had clearly shown from the assessment proceedings that
the gifts were made out of love and affection towards the assessee, and it
is a matter of God’s grace to create love and affection between donors and
donee, and that to have love and affection between two persons, blood
relation is not required, and looking to the status of the donors, the
amount gifted was very meager. Then it was found by the CIT(A) that the
assessee has also furnished the copies of the gift deeds and affidavits of
the donors. In the opinion of the CIT(A), it is not a case where the
assessee had first given such amounts to the donors, and the donors
returned back to the assessee by way of gift. The CIT(A) had gone through
the bank accounts of the donors, copies thereof are on record, and found
that there was sufficient cash balance on the date of gift to the
assessee, in respect of both the donors, and thus, the addition was
deleted.

(iv) The Tribunal has affirmed this finding by relying
upon certain judgments.

Nirav Shah

Capital gains : Income from sale of milk : Sale of calves : Cost of acquisition not ascertainable : Capital gain not chargeable

New Page 1

22 Capital gains : Assessee deriving
income from sale of milk : Sale of calves : Cost of acquisition not
ascertainable : Capital gain not chargeable to tax.

[Dy. CIT v. Smt. Suniti Singh, 215 CTR 326 (MP)]

The assessee was running a dairy and was deriving income
from sale of cow milk. In the relevant year, the assessee had sold calves. The
assessee claimed that the profit on sale of calves is not chargeable to tax as
the cost of acquisition is not ascertainable. The Assessing Officer observed
that the assessee had claimed depreciation on calves forming a part and parcel
of the live stock and, therefore, it was stock in trade of the assessee and
income from the sale of such stock in trade is liable to tax. Accordingly, the
Assessing Officer made an addition of Rs.68,000. The Tribunal accepted the
assessee’s claim and deleted the addition.

On appeal by the Revenue, the Madhya Pradesh High Court
upheld the decision of the Tribunal and held as under :

“(i) The business of the assessee relates to sale of milk
and the female cows constitute assets and they are exploited for production
of milk. The primary motive of the assessee is to fertilise the cows so that
they can yield milk. The income is derived through sale of milk and all
expenses which have gone into are to upkeep them and maintenance of cows,
like purchase of fodder, medicines, etc. are exclusively designed for
obtaining milk and the said expenditure has been shown as revenue
expenditure in the P&L a/c.

(ii) The calves came into being in the process so that
the female cows can be utilised to produce and eventually the milk is sold.
The male calves are sold as they are of no value to the assessee as they
cannot produce milk. There is no material on record to show that the selling
of calves is a part of the business activity of the assessee. Facts brought
on record clearly show that the asessee is engaged in the business activity
which relates to sale of milk.

(ii) The Tribunal is right in holding that the sale of
calves by the assessee cannot be regarded as capital gain since the cost of
acquisition is not ascertainable.”

Nirav Shah

Manufacture — Twisting and texturising partially oriented yarn amounts to manufacture in terms of S. 80-IA of the Act.

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15 Manufacture — Twisting and texturising partially oriented
yarn amounts to manufacture in terms of S. 80-IA of the Act.

[CIT v. Emptee Poly-Yarn P. Ltd., (2010) 320 ITR 665 (SC)]

The short question which arose for determination in a batch
of civil appeals before the Supreme Court was : Whether twisting and texturising
of partially oriented yarn (‘POY’ for short) amounted to ‘manufacture’ in terms
of S. 80-IA of the Income-tax Act, 1961 ?

The Supreme Court observed that it has repeatedly recommended
to the Department, be it under the Excise Act, the Customs Act or the Income-tax
Act, to examine the process applicable to the product in question and not to go
only by dictionary meanings, but this recommendation is not being followed over
the years.

The Supreme Court having examined the process in the light of
the opinion given by the expert, which had not been controverted, held that POY
was a semi-finished yarn not capable of being put in warp or weft, it could only
be used for making a texturised yarn, which, in turn, could be used in the
manufacture of fabric. In other words, POY could not be used directly to
manufacture fabric. According to the expert, crimps, bulkiness, etc. were
introduced by a process, called as thermo mechanical process, into POY which
converts POY into a texturised yarn. According to the Supreme Court, if one
examined this thermo-mechanical process in detail, it would become clear that
texturising and twisting of yarn constituted ‘manufacture’ in the context of
conversion of POY into texturised yarn.

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Nirav Shah

Minimum Alternative Tax — For making an addition under clause (b) of S. 115JB, two conditions must be jointly satisfied, namely, (i) there must a debit to the profit and loss account, and (ii) the amount so debited must be carried to the reserve.

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14 Minimum Alternative Tax — For making an addition under
clause (b) of S. 115JB, two conditions must be jointly satisfied, namely, (i)
there must a debit to the profit and loss account, and (ii) the amount so
debited must be carried to the reserve.

[National Hydroelectric Power Corporation Ltd. v. CIT, (2010)
320 ITR 374 (SC)]

The assessee was required to sell electricity to State
Electricity Board(s), Discoms, etc., at tariff rates notified by the CERC. The
tariff consists of depreciation, Advance Against Depreciation (AAD), interest on
loans, interest on working capital, operation and maintenance expenses, return
on equity.

On May 26, 1997, the Govt. of India introduced a mechanism to
generate additional cash flow, by allowing companies to collect AAD by way of
tariff charge. The year in which normal depreciation fell short of the original
scheduled loan repayment instalment (capped at 1/12th of the original loan) such
shortfall would be collected as advance against future depreciation.

According to the Authority for Advance Rulings (AAR), the
assessee supplied electricity at tariff rate notified by the CERC and recovered
the sale price, which became its income; that, in future the said sale price was
neither refundable nor adjustable against future bills.

However, according to the Authority of Advance Ruling (AAR),
when it came to computation of book profit, the assessee deducted the AAD
component from the total sale price and only the balance amount net of the AAD
was taken into the profit and loss account and book profit. Consequently, the
AAR ruled that reduction of the AAD from the ‘sales’ was nothing but a reserve
which had to be added back on the basis of clause (b) of Explanation 1 to S.
115JB of the Income-tax Act, 1961.

The Supreme Court held that on reading Explanation 1, it was
clear that to make an addition under clause (b) two conditions must be jointly
satisfied :

(a) There must be a debit of the amount to the profit and
loss account.

(b) The amount so debited must be carried to the reserve.

Since the amount of AAD was reduced from sales, there was no
debit in the profit and loss account, the amount did not enter the stream of
income for the purposes of determination of net profit at all, hence clause (b)
of Explanation 1 was not applicable. It was not an appropriation of profits. AAD
was not meant for an uncertain purpose. AAD was an amount that is under
obligation, right from the inception, to get adjusted in the future hence, could
not be designated as a reserve. AAD was nothing but an adjustment by reducing
the normal depreciation includible in the future years in such a manner that at
the end of the useful life of the plant (which is normally 30 years), the same
would be reduced to nil.

According to the Supreme Court the AAD was a timing
difference, it was not a reserve, it was not carried through the profit and loss
account and that it was ‘income received in advance’ subject to adjustment in
future and, therefore, clause (b) of Explanation 1 to S. 115JB was not
applicable.

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Nirav Shah

Manufacture — Duplication from the master media of the application software commercially to sub-licence a copy of such application software constitutes manufacturing of goods in terms of S. 80-IA.

New Page 1

13 Manufacture — Duplication from the master media of the
application software commercially to sub-licence a copy of such application
software constitutes manufacturing of goods in terms of S. 80-IA.

[CIT v. Oracle Software India Ltd., (2010) 320 ITR 546 (SC)]

The assessee, a 100% subsidiary of Oracle Corporation, USA,
was incorporated with the object of developing designing, improving, producing,
marketing, distributing, buying, selling and importing of computer software. The
assessee was entitled to sub-licence the software development by Oracle
Corporation, USA. The assessee imported master media of the software from Oracle
Corporation, USA which it duplicated on blank discs, packed and sold in the
market along with relevant brochures. The assessee made a payment a lump-sum
amount to Oracle Corporation, USA for the import of master media. In addition
thereto, the assessee also had to pay royalty at the rate of 30% of the price of
the licensed product. The only right which the assessee had was to replicate or
duplicate the software. It did not have any right to vary, amend or make value
addition to the software embedded in the master media. According to the assessee,
it used machinery to convert blank CDs into recorded CDs which along with other
processes became a software kit. According to the assessee, the blank CD
constituted raw materials. According to the assessee, the master media could not
be conveyed as it is. In order to sub-licence, a copy thereof had to be made and
it was the making of this copy which constituted manufacture or processing of
goods in terms of S. 80-IA and consequently the assessee was entitled to
deduction under that Section. On the other hand, according to the Department, in
the process of copying, there was no element of manufacture or processing of
goods. According to the Department, since the software on the master media and
the software on the recorded media remained unchanged, there was no manufacture
or processing of goods involved in the activity of the copy or duplicating,
hence, the assessee was not entitled to deduction u/s.80-IA. According to the
Department, when the master media was made from what was lodged into the
computer, it was a clone of the software in the computer and if one compared the
contents of the master media with what was there in the computer/data bank,
there was no difference, hence, according to the Department, there was no change
in the use, character or name of the CDs even after the impugned process was
undertaken by the assessee.

The Supreme Court observed that duplication could certainly
take place at home, however, one should draw a line between duplication done at
home and commercial duplication. Even a pirated copy of a CD was a duplication,
but that did not mean that commercial duplication as it was undertaken in the
instant case should be compared with home duplication which may result in
pirated copy of a CD.

The Supreme Court held that from the details of Oracle
applications, it found that the software on the master media was an application
software. It was not an operating software. It was not a system software. It
could be categorised into product line applications, application solutions and
industry applications. A commercial duplication process involved four steps. For
the said process of commercial duplication, one required master media, fully
operational computer, CD blaster machine (a commercial device used for
replication from master media), blank/
unrecorded compact disc also known as recordable media and printing
software/labels. The master media was subjected to a validation and checking
process by software engineers by installing and rechecking the integrity of the
master media with the help of the software installed in the fully operational
computer. After such validation and checking of the master media, the same was
inserted in a machine which was called the CD Blaster and a virtual image of the
software in the master media was thereafter created in its internal storage
device. This virtual image was utilised to replicate the software on the
recordable media.

According to the Supreme Court, if one examined the above
process in the light of the details given hereinabove, commercial duplication
could not be compared to home duplication. Complex technical nuances were
required to be kept in mind while deciding issues of the above nature. The
Supreme Court held that the term ‘manufacture’ implies a change, but every
change is not a manufacture, despite the fact that every change in an article is
the result of a treatment of labour and manipulation. However, this test of
manufacture needs to be seen in the context of the above process. If an
operation/process renders a commodity or article fit for use for which it is
otherwise not fit, the operation/process falls within the meaning of the word
‘manufacture’. Applying the above test to the facts of the present case, the
Supreme Court was of the view that, in the instant case, the assessee had
undertaken an operation which rendered a blank CD fit for use which it was
otherwise not fit. The blank CD was an input. By the duplicating process
undertaken by the assessee, the recordable media which was unfit for any
specific use got converted into the programme which was embedded in the master
media and, thus, the blank CD got converted into recorded CD by the aforestated
intricate process. The duplicating process changed the basic character of a
blank CD, dedicating it to a specific use. Without such processing, blank CDs
would be unfit for their intended purpose. Therefore, processing of blank CDs,
dedicating them to a specific use, constituted a manufacture in terms of S.
80-IA(12)(b) read with S. 33B of the Income-tax Act.

levitra

Nirav Shah

Capital gains — Gains/loss arising on renunciation of right to subscribe is a short-term gain — Deduction u/s.48(2) is to be applied to the long-term capital gains before set-off of short-term loss, if any.

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11 Capital gains — Gains/loss arising on renunciation of
right to subscribe is a short-term gain — Deduction u/s.48(2) is to be applied
to the long-term capital gains before set-off of short-term loss, if any.

[Navin Jindal v. ACIT, (2010) 320 ITR 708 (SC)]

The assessee was a shareholder in Jindal Iron and Steel
Company Limited (‘JISCO’, for short). The said company announced in January,
1992, an issue of 12.5% equity secured PCDs (party convertible debentures) of
Rs.110 for cash at par to shareholders on rights basis and employees on
equitable basis. The issue opened for subscription on February 14, 1992, and
closed on March 12, 1992. As the assessee held 1500 equity shares of JISCO, the
assessee received an offer to subscribe to 1875 PCDs of JISCO on rights basis.
The assessee renounced his right to subscribe to the PCDs in favour of Colorado
Trading Company on February 15, 1992, at the rate of Rs.30 per right. The
assessee received, accordingly, Rs.56,250 for renunciation of the right to
subscribe to the PCDs. Against the aforesaid sale consideration, the assessee
suffered a diminution in the value of the original 1500 equity shares in the
following manner : the cum-rights price per share on January 3, 1992, was
Rs.625, whereas ex-rights price per share on January 6, 1992, was Rs.425,
resulting in a loss of Rs.200 per share. Consequently, the capital loss suffered
by the assessee was Rs.3,00,000 (1,500 x 200) as against the receipt of
Rs.56,250 on renunciation of 1875 PCDs.

During that year on August 7, 1991, the assessee sold 8460
equity shares of JSL at Rs.240 for a total consideration of Rs.20,30,400, whose
cost of acquisition was Rs.3,63,200 and, consequently, the transaction resulted
in a long-term gain for the assessee in the sum of Rs.16,67,200. Similarly, on
June 20, 1991, the assessee sold 7000 equity shares of Saw Pipes Limited (‘SPL’,
short) at the rate of Rs.103 each, for a total consideration of Rs.7,21,000 from
which the assessee deducted Rs.70,000 towards cost of acquisition, resulting in
a long-term gain of Rs.6,51,000. In all, under the caption, ‘long-term gain’ the
assessee earned Rs.23,18,200 (Rs.16,67,200 + Rs.6,51,000).

The Supreme Court observed that the question of loss was not
in issue in the civil appeals before it. The only question which it had to
decide was the nature of the loss. The Assessing Officer had accepted the
computation of loss on renunciation of the right to subscribe to the PCDs at
Rs.2,43,750, but treated the same as long-term capital loss.

The Supreme Court observed that S. 48 deals with the mode of
computation of income chargeable under the head ‘Capital gains’. Under that
Section, such income is required to be computed by deducting from the full value
of the consideration received as a result of the transfer of the capital asset,
the expenditure incurred wholly and exclusively in connection with such transfer
and the cost of acquisition of the asset. U/s.48(1)(b) of the Act, it is further
stipulated that where the capital gain arises from the transfer of a long-term
capital asset, then, in addition to the expenditure incurred in connection with
the transfer and the cost of acquisition of the asset, a further deduction, as
specified in S. 48(2) of the Act, which is similar to standard deduction,
becomes necessary.

The Supreme Court noted that the basic controversy in the
batch of civil appeals before it concerned the stage at which S. 48(2) of the
Act becomes applicable.

The Supreme Court noted that from the said figure of
Rs.23,31,200, the Assessing Officer had deducted the loss of Rs.2,43,680 as a
long-term loss and applied S. 48(2) deduction to the figure of Rs.20,87,450.
Consequently, the Assessing Officer worked out the net income at Rs.8,28,980 as
against the figure of Rs.6,77,530 worked out by the assessee. The above analysis
showed the controversy between the parties. The assessee treated Rs.2,43,750 as
a short-term loss, and, therefore, he applied the standard deduction u/s. 48(2)
to the long-term gain of Rs.23,18,200 from sale of shares of JSL and SPL,
whereas the Assessing Officer applied S. 48(2) deduction to the figure of
Rs.20,87,450 which is arrived at on the basis that the loss suffered by the
assessee of Rs.2,43,680 was a long-term loss.

The Supreme Court held that the right to subscribe for
additional offer of share/debentures on rights basis, on the strength of
existing shareholding in the company, comes into existence when the company
decides to come out with the rights offer. Prior to that, such right, though
embedded in the original shareholding, remains inchoate. The same crystallises
only when the rights offer is announced by the company. Therefore, in order to
determine the nature of the gain/loss on renunciation of right to subscribe for
additional shares/debentures, the crucial date is the date on which such right
to subscribe for additional shares/debentures comes into existence and the date
of transfer (renunciation) of such right. The said right to subscribe for
additional shares/debentures is a distinct, independent and separate right,
capable of being transferred independently of the existing shareholding, on the
strength of which such rights are offered.

The right to subscribe for additional offer of
shares/debentures comes into existence only when the company decides to come out
with the rights offer. It is only when that event takes place, that diminution
in the value of the original shares held by the assessee takes place. One has to
give weightage to the diminution in the value of the original shares, which
takes place when the company decides to come out with the rights offer. For
determining whether the gain/loss of renunciation of the right to subscribe is a
short-term or long-term gain/loss, the crucial date is the date on which such
right to subscribe for additional shares/debentures comes into existence and the
date of renunciation (transfer) of such right.

The Supreme Court was therefore of the opinion that the loss
suffered by the assessee amounting to Rs.2,43,750 was short-term loss. According
to the Supreme Court, the computation of income under the head ‘Capital gains’,
as computed by the assessee was correct.

Nirav Shah

Manufacture or production of article or thing — Activity of extraction of marble blocks, cutting into slabs, polishing and conversion into polished slabs and tiles would amount to ‘manufacture’ or ‘production’ for the purpose of claiming deduction u/s.80-

New Page 1

12 Manufacture or production of article or thing — Activity
of extraction of marble blocks, cutting into slabs, polishing and conversion
into polished slabs and tiles would amount to ‘manufacture’ or ‘production’ for
the purpose of claiming deduction u/s.80-IA of the Act.

[ITO v. Arihant Tiles and Marbles P. Ltd., (2010) 320 ITR 79
(SC)]

In the batch of civil appeals before the Supreme Court, a
common question of law which arose for determination was : Whether conversion of
marble blocks by sawing into slabs and tiles and polishing amounted to
‘manufacture or production of article or thing’, so as to make the
respondent(s)-assessee(s) entitled to the benefit of S. 80-IA of the Income-tax
Act, 1961, as it stood at the material time.

According to the Supreme Court, to answer the above issue, it
was necessary to note the details of stepwise activities undertaken by the
assessee(s) which read as follows :

(i) Marble blocks excavated/extracted by the mine owners
being in raw uneven shapes had to be properly sorted out and marked;

(ii) Such blocks were then processed on single blade/wire
saw machines using advanced technology to square them by separating waste
material;

(iii) Squared up blocks were sawed for making slabs by
using the gang-saw machine or single/multiblock cutter machine;

(iv) The sawn slabs were further reinforced by way of
filling cracks by epoxy resins and fiber netting;

(v) The slabs were polished in polishing machine; the slabs
were further edge-cut into required dimensions/tiles as per market requirement
in perfect angles by edge-cutting machine and multidisc cutter machines;

(vi) Polished slabs and tiles were buffed by shiner.

The Supreme Court further noted that the assessee(s) had been
consistently regarded as a manufacturer/producer by various Government
departments and agencies. The above processes undertaken by the respondent(s)
had been treated as manufacture under the Excise Act and allied tax laws.

At the outset, it was observed by the Supreme Court that in
numerous judgments, it had been consistently held that the word ‘production’ was
wider in its scope as compared to the word ‘manufacture’. Further, the
Parliament itself had taken note of the ground reality and amended the
provisions of the Income-tax Act, 1961, by inserting S. 2(29BA) vide the Finance
Act, 2009, with effect from April 1, 2009.

The Supreme Court noted that the authorities below had
rejected the contention of the assessee(s) that its activities of polishing
slabs and making of tiles from marble blocks constituted ‘manufacture’ or
‘production’ u/s.80-IA of the Income-tax Act. There was a difference of opinion
in this connection between the Members of the Income-tax Appellate Tribunal.
However, by the impugned judgment, the High Court had accepted the contention of
the assessee(s) holding that in the present case, polished slabs and tiles stood
manufactured/produced from the marble blocks and, consequently, each of the
assessee was entitled to the benefit of deduction u/s.80-IA. Hence, the civil
appeals were filed by the Department.

The Supreme Court also noted that in these cases, it was
concerned with assessees who were basically factory owners and not mine owners.

The Supreme Court held that in each case one has to examine
the nature of the activity undertaken by an assessee. Mere extraction of stones
may not constitute manufacture. Similarly, after extraction, if marble blocks
are cut into slabs that per se will not amount to the activity of manufacture.
From the details of process undertaken by each of the respondents it was clear
that they were not concerned only with cutting of marble blocks into slabs but
were also concerned with the activity of polishing and ultimate conversion of
blocks into polished slabs and tiles. The Supreme Court found from the process
indicated hereinabove that there were various stages through which the blocks
had to go through before they become polished slabs and tiles. In the
circumstances, the Supreme Court was of the view that on the facts of the cases
in hand, there was certainly an activity which would come in the category of
‘manufacture’ or ‘production’ u/s.80IA of the Income-tax Act. The Supreme Court
held that in the judgment in Aman Marble Industries P. Ltd. (2003) 157 ELT 393
(SC), it was not required to construe the word ‘production’ in addition to the
word ‘manufacture’.

Before concluding, the Supreme Court thought it fit to make
one observation. The Supreme Court observed that if the contention of the
Department was to be accepted, namely, that the activity undertaken by the
respondents herein was not a manufacture, then it would have serious revenue
consequences. As stated above, each of the respondents was paying excise duty,
some of the respondents were job workers and activity undertaken by them had
been recognised by various Government authorities as manufacture. To say that
the activity would not amount to manufacture or production u/s.80-IA would have
disastrous consequences, particularly in view of the fact that the assessees in
all the cases would plead that they were not liable to pay excise duty, sales
tax, etc. because the activity did not constitute manufacture. Keeping in mind
the above factors, the Supreme Court was of the view that in the present cases,
the activity undertaken by each of the respondents constituted manufacture or
production and, therefore, they would be entitled to the benefit of S. 80-IA of
the Income-tax Act, 1961.

Nirav Shah

Interest — Tax — Interest as Government securities not chargeable to Interest Tax

New Page 1

Interest — Tax — Interest as Government securities not
chargeable to Interest Tax

[CIT vs. Ratnakar Bank Ltd. (2008) 305 ITR 257 (SC)].

The question involved before the Supreme Court was whether
interest earned by the assessee-bank on Government securities was liable to be
assessed under Section 2(7) of the Interest-tax Act ? The Tribunal had held
that it was not chargeable. The High Court had upheld the view of the
Tribunal. The Supreme Court observed that the issue was considered by it
earlier in CIT vs. Corporation Bank, (2007) 295 ITR 193 (SC), wherein
the appeals filed by the Department were dismissed. However, the learned
counsel for the Department submitted that the said decision related to the
interest on Government securities. The learned counsel for the assessee
submitted that in the instant case, the interest earned was on Government
securities only. This stand was denied by the learned counsel for the
Department. In the circumstances, the Supreme Court remitted the matter back
to the Tribunal to examine the factual position as to whether the interest
involved in the present case was on Government securities. The Supreme Court
clarified that if the interest was earned on Government securities, the ratio
of the decision in Corporation Bank’s case would apply to the facts of the
present case and if the interest earned was not solely on Government
securities, the ratio of the decision would not apply.

levitra

Nirav Shah

Appeal — Order set aside to the High Court as the relevant decision was not considered.

New Page 2

12. Appeal — Order set aside to the High Court as the
relevant decision was not considered.

[CIT vs. Madras Engineering Construction Co-op. Society
Ltd., (2008) 306 ITR 10 (SC)].

The Assessing Officer negatived the claim of deduction
under Section 80P(2)(a)(i) of the Act on the ground that the income reflected
by the assessee can neither be attributed to actual labour of the members nor
can be treated as arising out of collective disposal of its labour. The
Commissioner of Income Tax (Appeals) following the earlier orders, allowed the
appeal. The Tribunal dismissed the Revenue’s appeals. Before the Supreme
Court, the Revenue contended that the High Court had failed to notice that the
profit earned by the Society in executing the work was retained by the members
themselves. The Supreme Court, however, found that its decision in Madras
Auto Rickshaw Drivers’ Co-op. Society vs. CIT, (2001) 249 ITR 330 (SC),
which had prima facie relevance, was not noticed by the High Court. The
Supreme Court therefore set aside the order of the High Court and remitted the
matter to it for a fresh consideration in the light of the aforesaid decision.

Nirav Shah

The European Economic Crisis

Editorial

The recent crisis in various European countries (four of the
worst affected being commonly referred to as PIGS — Portugal, Ireland, Greece,
Spain) has again thrown the budding worldwide economic recovery into a spin. The
near default by Greece and the heavy cost of the bailout by the European Union
has had a huge effect on markets worldwide, and is bound to affect various
countries around the world. Italy is thanking its stars that the ‘I’ in PIGS no
longer stands for Italy but for Ireland, but the rest of the world is wondering
whether Italy too would go the same way as the others, given some of the common
economic parameters that it has with those countries.

This is the other side of globalisation that we see. The
Euro, the common currency for Europe, which was hailed as a significant step for
integration of the European economy when it was implemented, is now in danger of
having countries break away from it. It was a well-known fact that the European
Union consisted of diverse economies — some well-developed and economically
conservative, while others not so well developed but profligate in their
spending without having the economic resources to do so. Conservative Germans
are rightly indignant at having to bail out profligate Greece, but because of
the Euro, and the impact on their banks and economy, have no choice but to
support Greece. Greece has its hands partly tied in tiding over the crisis
because it is part of the Euro, and therefore unable to devalue its currency. It
naturally expected the European Union to bail it out.

India too has important lessons to learn from the European
crisis. India is similar to Europe in the sense that India too consists of
various states having a common currency, just as Europe consists of various
countries having a common currency. Each state has its own finances and
expenditure, just as each country in Europe has its own finances and
expenditure. Just as Greece merrily continued to spend, without the requisite
revenues, relying totally on the European Union to bail it out, in India too we
have various states which have launched various populist programmes without the
funds to sustain such programmes, hoping that the Central Government would bail
them out if they were to land in difficulty.

Perhaps the one major difference is that the Indian federal
revenues and the federal expenses are a far higher percentage of the total
Government revenues and expenses than the common revenues and expenses of the
European Union are to the total European revenues and expenses. Also, in India,
certain major economic decisions are taken by the federal government, which
decisions may be the prerogative of the individual countries in Europe.

The Greek crisis was caused by the fact that during the
economic boom, Greece did not use the opportunity to carry out much-needed
reforms. Tax evasion is still rampant in Greece, resulting in significant
leakage of tax revenues due to the government. The Greek government has been
merrily spending without regard to its revenues, thereby running large deficits.

In India too, the reforms agenda has been lagging of late.
Tax evasion is still fairly high, though it has reduced in recent times. The
Indian government’s increase in spending in recent times probably outshadows
that of Greece. The fuel subsidy, the fertiliser subsidy, the food subsidy, and
various other schemes have resulted in drastic increases in the government
deficit. The worry is that there does not seem to be any significant efforts to
reduce the deficit through reduced government spending. So far, the government
has been able to manage on account of one-time collections, such as
disinvestment of public sector companies, auction of telecom spectrum, etc. The
question is — how long can sale of capital assets continue to sustain government
expenditure ?

Sooner or later, the government will run out of options and
have to either increase taxes (which seems difficult under the current
scenario), improve tax compliance, or reduce Government spending (which again
seems unlikely, given the populist measures that are generally resorted to).
Improvement of tax compliance to boost tax revenues seems the only possible
realistic way. Such measures will be required, and we cannot bank on the fact
that since we are currently growing at a brisk pace as compared to the rest of
the world, and are a popular investment destination, we would be immune from
similar economic crises. It does not take long for business confidence to
evaporate, and it is far better that we take measures before we are forced to do
so.

We are fortunate that we have an economist at the helm of
affairs of our country in such times. However, given the fact that the current
government has to adjust to the whims and fancies of other political parties in
order to survive, the room for much-needed reform is practically limited. Can
our opportunistic politicians not cast aside their personal greed and agenda for
the time being, and act in the country’s best interest by supporting the
government in its economic reforms ?

Our economy is already feeling the effects of the European
crisis. Our stock markets have stumbled, the rupee has become volatile against
other currencies, and exporters to Europe will shortly start feeling the crunch.
Foreign capital may flow out from the Indian stock markets to safer assets.
Interest rates and inflation may move up. One does not know how long the problem
will continue and how much the European economy will worsen before things
improve for the better.

The silver lining in the crisis may be that the bubble in the
Indian real estate sector, which was primarily caused by inflows from abroad,
may deflate, causing real estate prices to return to reasonable levels. One
hopes and wishes that the Indian economy continues its steady growth without too
many hiccups.

Gautam Nayak

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Nirav Shah

Prosperity without Security ?

Editorial

The elections have thrown up a
pleasant surprise in the form of a relatively stable government. The stock
markets are booming in anticipation of a fiscal stimulus package and economic
reforms. It is almost as if the markets believe that the worst of the recession
is now behind us and that henceforward it is all smooth sailing for the country.
Is this really justified ?

With a stable government in
place committed to economic reforms, it is highly likely that India would not be
as badly affected by the worldwide recession as other countries, and would be
able to ride out the storm. The real problem facing the country’s growth however
lies elsewhere — in the stability of our neighbourhood. Growth is not
sustainable without stability.

In the last few months, we have
seen an internal battle being waged by the Pakistani Government against the
fundamentalist Taliban, and the threat being posed by such fundamentalist forces
to the very existence of Pakistan. The monster created by the Pakistani
Government now threatens to engulf the entire country. Such proximity to our
borders, given the attitude of such fundamentalist forces towards India and the
violent methods being used to achieve their ends, is bound to create security
problems within India, endangering the prospects of growth. The very thought
that Pakistan’s nuclear weapons may fall into the hands of such fundamentalists
is a cause of great concern.

On our northern borders, Nepal,
which had so far not posed a problem to India’s security, is facing serious
internal problems. The Maoists who had given up their violent tactics to join
the Government, had to quit. India is being blamed for their plight, and the
Maoists are unlikely to take things lying down. Their making common cause with
China is bound to create security issues for India. Whether the Maoists are in
power or out of power, Nepal is likely to be a thorn in India’s security for the
next few years.

On the eastern front, though
relations with Bangladesh have improved for the time being, the politics of
Bangladesh being what it is, one wonders how long this improved relationship
will last. India’s border debate with China remains unresolved, with issues
suddenly raising their heads from time to time.

To top it all, many Indian
States are facing violent tactics of Maoists and Naxalites. All in all, India
seems to be situated in the most dangerous location worldwide, so far as the
safety and security of its residents are concerned. The top priority of the new
Government should therefore be to take measures to improve the internal and
external security of the country.

This involves not merely the
strengthening of internal security forces and the armed forces, but also making
the right moves in respect of our foreign policy. Economic reforms can take a
country far, but security of life and property is essential for the business
sector to flourish. Over the past decade, India has been seen as an attractive
investment and business destination on account of its comparatively peaceful
atmosphere. To some extent, this image has taken a beating due to the series of
recent terrorist attacks.

No country can hope to be
regarded as an attractive place to do business unless peace prevails there. Take
the cases of Vietnam, Ireland, and so many others. Once ravaged by war or civil
war, these countries were then regarded as death-traps. Today, these are
considered as investment destinations worldwide, on account of the peace and
stability that they have enjoyed for over a decade.

The biggest challenge before
the new Government is to take steps to ensure that peace and internal stability
are maintained, notwithstanding the developments in our immediate neighbourhood.
Our arms purchases, our expenditure on defence and police, should not be victim
to party politics or corruption, but should be regarded as an essential
expenditure for national growth. Our foreign policy should be guided by
long-term considerations of peaceful co-existence and not by short-term
prejudices of the party in power, nor by ambitions of becoming a super power.
This is an opportunity for this Government to show that right approach can make
a difference. Only time will tell whether our hopes will be realised or not !

Gautam Nayak

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Nirav Shah

Taxing Charity

Editorial

The recent amendments to the Income Tax Act carried out by
the Finance Act 2008 in relation to taxation of charitable trusts reflect very
poorly on the Government, and raise serious doubts as to its intentions. It
seems to be part of a disturbing trend to punish all for the transgressions of a
few.

On the face of it, the amendment seems innocuous. The
definition of charitable purpose has been amended to provide that one of the
limbs, any other object of general public utility, shall not include the
carrying on of any activity in the nature of trade, commerce or business, or any
activity of rendering any service in relation to any trade, commerce or
business, for a cess or fee or any other consideration, irrespective of the
nature of use or application or retention of the income from such activity.

The ostensible reason for such amendment given by the
Government is that it desires to deny the benefit of exemption to purely
commercial and business entities, which wear the mask of a charity. A very
plausible reason indeed !

However, the amendment goes far beyond the stated reason. It
not only covers such business activities, but also activities which are
rendering services in relation to trade, commerce or business. The term ‘in
relation to’ being a very broad term, would rope in various activities carried
out by charitable trusts genuinely to raise funds for their other charitable
activities.

To illustrate, some of the charitable activities which may be
impacted include activities such as micro-credit, sale of greeting cards with
designs painted by the handicapped, sale of products manufactured by handicapped
persons, issue of certificates of origin by chambers of commerce, organising of
seminars, trade fairs and exhibitions, etc. These are all activities, which are
part of the objects, but are subservient to the main object. Carrying on any
such activity could result in complete loss of the exemption. Fortunately, pure
fund-raising activities may not be impacted.

Today, charity is not restricted to traditional activities of
education, medical relief or relief of poverty. Most NGOs carry on activities in
different spheres, which help improve the life of the general public. Be it
protection of the environment, eradication of corruption and promotion of
transparency in Government, improving the lot of tribals or other disadvantaged
groups, promotion of art and culture — all these are equally charitable
activities, though there may be some involvement of business for fund-raising,
assistance, etc.

No less a person than the former Prime Minister Rajiv Gandhi,
as well as his son (and heir-apparent?) Rahul Gandhi, have acknowledged that
only a fraction of funds spent by the Government for welfare of the downtrodden
actually reach the intended beneficiaries, and that NGOs can provide a far
superior delivery mechanism. In such circumstances, should the Government not be
promoting the activities of NGOs, rather than seeking to transfer funds from
NGOs to itself ? Ultimately, Government is supposed to exist for the people.
Should the need of and benefit to the general public not be the paramount
guiding factor in such matters ?

The Finance Minister has gone on record to clarify that
genuine charitable organisations will not in any way be affected, and that the
activities of Chambers of Commerce and similar organisations rendering services
to their members would continue to be regarded as “advancement of any other
object of general public utility”. If that indeed was the intention, what
prevented the Government from reflecting such intention in the provisions of the
law itself ? Are we to believe that the Government is incapable of expressing
its intention through precise wording of the law ? And that too when we have an
eminent lawyer at the helm of the Finance Ministry ?

We are further told that the CBDT, as usual, will come out
with an explanatory circular containing guidelines for determining whether an
entity is carrying on any activity in the nature of trade, commerce or business
or any activity of rendering any service in relation to any trade, commerce or
business. Of late, it is noticed that such circulars do not provide any guidance
on debatable issues, but merely parrot the provisions of the section. One hopes
that at least this time the circular will really be explanatory !

Such circulars explaining provisions of the Finance Act are
generally issued by the CBDT only in December. Do charitable trusts have to keep
their activities on hold till December to find out whether their activities are
permissible or not, or to know whether they are liable to pay advance tax or
not ? One hopes that one is proved wrong for once, and at least on this aspect,
a circular is issued immediately. Not to do so is to do grave injustice to
charity and cause a severe loss to the general public !

Gautam Nayak

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Nirav Shah

Appeal to Tribunal : Powers of Single member : S. 255(3) : Income computed by AO less than Rs.5 lakhs : CIT(A) enhanced it to more than Rs.5 lakhs : Single member can decide appeal.

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21 Appeal to Tribunal : Powers of Single
member : S. 255(3) of Income-tax Act, 1961 : A.Y. 1996-97 : Income computed by
AO less than Rs.5 lakhs : CIT(A) enhanced it to more than Rs.5 lakhs : Single
member can decide the appeal.

[CIT v. Mahakuteshwar Oil Industries, 298 ITR 390
(Kar.)]

The assessee was a manufacturer of edible oil. For the A.Y.
1996-97, it had declared the total income of Rs.8,660 in the return of income.
The Assessing Officer computed the total income at Rs.2,27,614. The Commissioner
enhanced the income to Rs.13,89,795. In appeal before the Tribunal, the Single
Member of the Tribunal decided the appeal and granted relief to the assessee.

In the appeal preferred by the Revenue, the following
questions were raised :

“(i) Whether the single member of the Tribunal had
jurisdiction to decide the appeal when the subject matter of appeal was
exceeding Rs.5,00,000 ?

(ii) Whether the Tribunal was justified in reversing the
findings of the Appellate Commissioner, when the assessee failed to discharge
the burden of proof as required u/s.68 of the Income-tax Act ?

The Karnataka High Court upheld the decision of the Tribunal
and held as under :

“(i) A single member of the Tribunal can exercise powers if
the income computed by the Assessing Officer is less than Rs.5 lakhs, even
though the same has been enhanced by the Commissioner (Appeals) in excess of
Rs.5 lakhs.

(ii) The Tribunal had given a categorical finding that the
assessee was willing to examine the creditors as its witnesses to prove that
it had availed of loans from them. No records were produced to show that the
assessee had not made such a statement either before the Assessing Officer or
before the Commissioner (Appeals). When the Revenue had got the records to
show whether the assessee was willing to examine any of the witnesses or not,
when such documents were not placed before the Court, one would have to draw
an adverse inference against the Revenue.”

levitra

Nirav Shah

Penalty : S. 271B r/w. ss. 44AB and 80P of I. T. Act, 1961 : Failure to get accounts audited within prescribed time : No tax payable by assessee society in view of s. 80P : Penalty u/s. 271B not to be imposed

New Page 1

Penalty : S. 271B r/w. ss. 44AB and 80P of I. T. Act,
1961 : Failure to get accounts audited within prescribed time : No tax payable
by assessee society in view of s. 80P : Penalty u/s. 271B not to be imposed.

[CIT vs. Iqbalpur Co-operative Cane Development Union
Ltd.; 179 Taxman 27 (Uttarakhand)].

The income of the assessee co-operative society was
exempted u/s. 80P of the Income-tax Act, 1961. The assessee society failed to
get its accounts audited u/s. 44AB of the Act within the prescribed time.
Therefore, the Assessing Officer imposed penalty u/s. 271B of the Act. The
Tribunal cancelled the penalty.

On appeal by the Revenue, the Uttarakhand High Court upheld
the decision of the Tribunal and held as under :

“i) There appeared no intention on the part of the
assessee to conceal the income or to deprive the Government of revenue as
there was no tax payable on the income of the assessee, in view of the
provisions of section 80P. Thus, it was not necessary for the Assessing
Officer to impose penalty u/s. 271B.

ii) On going through the impugned order passed by the
Tribunal, no sufficient reason was found to interfere with the satisfaction
recorded by the Tribunal as to the finding of fact that the assessee had no
intention to cause any loss to the revenue and as such, the penalty was not
necessarily required to be imposed by the Assessing Officer.

iii) Agreeing with the view of the Tribunal, it was to be
held that though an assessee is liable to penalty u/s. 271B for failure to
comply with the provisions of section 44AB but since in the instant case, no
tax was payable by the assessee in view of the provisions contained in
section 80P, the Tribunal had commited no error of law in setting aside the
penalty imposed by the Assessing Officer”.

levitra

Nirav Shah

Fair Value or Fear Value?

Accounting Standards

Fair value accounting is an integral aspect of International
Financial Reporting Standards (IFRS). In good times, everyone likes fair value
accounting, however, in bad times they are complaining. With the adoption of
IFRS from 2011 by India, the debate on fair value accounting has exacerbated.
Some argue that fair value accounting is procyclical and caused the recent
credit crisis. However subsequent research done by SEC indicates that financial
institutions collapsed because of credit losses on doubtful mortgages, caused by
sub-prime lending, and not fair value accounting.

Those criticising fair value accounting do not seem to
provide any credible alternatives. Do we take a step back to historical cost
accounting, wherein financial assets are stated at outdated values and hence not
relevant or reliable? Is there any better way of accounting for
derivatives, other than using fair value accounting ? For example, in the
case of long-term foreign exchange forward contracts there may not be an active
market. For such contracts, entities obtain MTM quotes from banks. In practice,
significant differences have been observed between quotes from various banks.
Though fair value in this case is judgmental, is it still not a much better
alternative than not accounting or accounting at historical price ?

Some years ago an exercise was conducted by a global
accounting firm to determine employee stock option charge. By making changes to
the input variables, all within the allowable parameters of IFRS, option expense
as a percentage of reported income was found to vary as much as 40% to 155%.
However, since then the IASB has issued an Exposure Draft on fair value
measurement, and overtime subjectivity and valuation spread is expected to
reduce substantially.

The next question is what kind of assets and liabilities lend
themselves better to fair value accounting. Whilst many non-financial assets
under IFRS are accounted at historical cost, biological assets are accounted at
fair value. Unfortunately many biological assets are simply not subject to
reliable estimates of fair value. Take for instance, a colt which is kept as a
potential breeding stock, grows into a fine stallion. The stallion starts
winning race events and is also used in Bollywood films. The stallion earns
substantial amount for its owner from breeding and other services. The stallion
gets older, his utility decreases. Eventually the stallion dies of old age and
the carcass used as pet food. At each stage in the life of the horse, the fair
value would change significantly, but estimating the fair values could be
extremely subjective and difficult. In many ways, the stallion reminds one of
fixed assets. Changes in fair value of fixed assets are not recognised in the
income statement, then why should the treatment be different in the case of
biological non-financial assets ?

In India the debate on fair value has got confused because of
lack of understanding of IFRS. For example, a common misunderstanding is that
all assets and liabilities are stated at fair value. However, the truth is that
under IFRS many non-financial assets such as fixed assets or intangible
assets are stated at cost less depreciation. In the case of investment
properties, a company is allowed to choose either the cost option or fair value
option for accounting. The apprehension of using fair value accounting for
investment properties is driven by tax considerations. However, one may note
that IFRS financial statements are driven towards the needs of the investor and
not of any regulator. Therefore, the income-tax authorities should ensure that
IFRS is tax neutral.

Being an emerging economy, without deep markets in many
areas, India would have specific challenges. Many of the challenges in
determining fair valuation applicable to emerging economies may also apply to
any other developed economy. However, lack of expertise and experience in
emerging economies may amplify the problem. Additional education might be needed
on how to make estimates and judgments and the disclosure of fair value in
financial statements.

Many emerging economies do not have a deep and active market
for long-term maturities, and in the case of corporate bond there may not be an
active market at all. Valuation of such bonds would be difficult as there would
be no market to mark, and estimating discount rate for longer-term maturities
could be challenging. A country may have only one risk premium that covers all
maturities but not broken up for specific duration or industry sector — this can
compound the problem.

Any valuation that involves tax and foreign exchange as a
variable will add another dimension of complication in the case of emerging
economies. This is because tax rates and regulations are not stable and
change quite frequently. Also, experience indicates that foreign exchange
reference rates announced by the central bank or a regulatory body may be
significantly different from the market. In the case of foreign exchange forward
contract, there may not be an active market beyond one year. Significant
differences have been observed in the MTM quotes from various banks on long-term
forward contracts.

If one has to value a corporate bond that is not actively
traded, the discount rate would be the base rate plus a credit rating-based
credit spread. There are various discounting curves available such as the
zero-coupon interest rate, yield to maturity rate, MIBOR, Fixed Income Money
Market and Derivative Association (FIMMDA) rate, etc. FIMMDA issues credit
rating-based credit spread on a monthly basis. Reuters issues credit spread on a
daily basis but only for AAA rated instruments. The reliability of the valuation
of the bond would depend upon (a) the reliability of the base rate used (b) the
availability and reliability of the credit rating for the instrument, and (c)
the reliability of the credit spread. If a company uses a particular curve to
discount a corporate bond (say, YTM curve) which is different from the
acceptable practice in the market (say, FIMMDA), then the value would differ
from how the market determines it.

Similar issues would also arise in the case of valuation of
government bonds. Many of them may be very illiquid, particularly the state
government bonds. Quotes from different brokers often differ significantly. Also
it is difficult to know if the brokers are acting as principal or agents and
whether the broker will fulfil the deal at the committed price. Valuing them in
the absence of a market may yield different results, as risk premium for state
governments may not be available and would certainly not be the same as that of
the central government. As per RBI requirements state government securities are
valued applying the YTM method by marking it up by 25 basis point, above the
yields of the central government securities of equivalent maturity. However,
under IFRS this approximation may not work, as it is clear that
different states have different risk profiles, which impacts their valuation.

Under IFRS a company may have to fair value its foreign currency convertible bond listed on a foreign securities exchange. However, in many instances at the reporting period there may be no trade as it may not be actively traded. This could lend itself to potential abuse as insignificant trades at the reporting date may inaccurately determine the fair value of the bonds. The appropriate thing to do in such situations is to make an adjustment to the quoted price based on a detailed analysis so as to measure the bond at its fair value.

It is also common in an emerging economy that an entity is required to estimate fair value of an unquoted instrument, without the benefit of detailed cash flow forecasts, management budgets, or robust multiples. An entity may own an insignificant amount, say, 10% of another entity, and therefore may not be legally entitled to obtain that information from the investee. In many cases, local benchmark companies or their financial information may simply not be available on which to base the valuation. It may be noted that RBI requires unquoted equity instruments to be valued at break-up value from the company’s latest available balance sheet, and in its absence, at Re.1 per company. Such valuations would not be acceptable under IFRS.

When estimating fair value in an emerging economy, modelling a non-financial variable could be extremely difficult. For example, under IFRS, acquisition accounting requires fair valuation of contingent liabilities of the acquiree. If the contingent liabilities were with regard to tax, in many developed economies there is a settlement system and past experience on which an estimate can be based. However, in emerging economies the litigations tend to be very long-drawn and uncertain, eventually resulting in a full liability or no liability at all. The tax authorities that influence the variable may change their behavior rapidly, thereby making the historical behaviour an inaccurate basis on which to predict future behaviour.

Sometimes market dynamics work in a very complicated manner in emerging economies. It may be difficult to determine the principal or most advantageous market due to regulatory or political circumstances. For example, a commodity market may have been cornered by a few selected players, and though in legal terms, all market participants can trade in the market, in actual terms it may be restrictive. Whether such a market should be considered in determining the fair value, if the market participant is not entirely clear whether it will be allowed entry and trade without any restriction ? Such questions would be more common in emerging economies.

Highest and best use is a concept that underscores fair valuation. As people are supposed to act rationally, a fair value measurement considers a market participant’s ability to generate economic benefit by using the asset in its highest and best use. However, highest and best use is subject to the restrictions of what is physically, legally and financially feasible. This could be a difficult area particularly in emerging economies, in the absence of clear laws or the manner in which they are implemented. For example, a builder that owns a piece of land, may not be clear, whether he will be allowed to construct 10 floors or 20 floors and whether the property development is restricted by laws in terms of its usage, for example, only for residential or commercial purposes, etc. This could make the valuation of the land a difficult task.

The above are issues that emerging economies may face more prominently than developed economies. In any system or methodology, fair valuation cannot be expected to provide, the same results if different valuers were valuing it. This is because it is not a science but an art and no guidance or methodology can ever make it a science. However, some additional guidance from the IASB on the above issues will certainly be helpful in bringing about clarity and consistency on how these issues are handled and in collapsing the range within which the fair value should fall. Issuance of guidance that specifically deals with fair valuation issues in emerging economies, will also reduce the resistance in these economies towards fair valuation.

To sum up, fair value accounting does not create good or bad news; rather it is an impartial messenger of the news. However, IASB should look at improvements in terms of providing guidance on a regular basis to reduce judgment and subjectivity as well as restricting the use of fair value accounting only to those assets and liabilities that lend themselves better to fair value accounting. IASB should also focus on providing specific guidance on the fair value challenges that emerging economies such as India would face.

Nirav Shah

Netting of interest and S. 80HHC

Controversies

1. Issue for consideration :

1.1 S. 80HHC, inserted by the Finance Act, 1983 w.e.f. 1st
April, 1983 for grant of deduction in respect of the profits derived from
exports of goods and merchandise, has since undergone several changes. The
relevant part of the provision, at present, relevant to this discussion, reads
as under :

“Explanation : For the purposes of this Section, :

(baa) ‘profits of the business’ means the profits of the
business as computed under the head ‘Profits and gains of business or
profession’ as reduced by :

(1) ninety per cent of any sum referred to in clauses (iiia),
(iiib), (iiic), (iiid) and (iiie) of S. 28 or of any receipts by way of
brokerage, commission, interest, rent, charges or any other receipt of a similar
nature included in such profits; and

1.2 ‘Profits of the business’ as defined in clause (baa) of
the Explanation requires that the profits derived from exports is computed under
the head ‘Profits and gains of business and profession’ and such profits
determined in accordance with S. 28 to S. 44D is to be further adjusted on
account of clause (baa), namely, ninety percent of any receipts by way of
brokerage, commission, interest, rent, charges or any other receipt of a similar
nature included in such profits.

1.3 The issue that is being fiercely debated, is concerning
the true meaning of the terms ‘interest, etc.’ and ‘receipts’ used in Expln.
(baa). Whether the terms individually or collectively connote net interest, etc.
i.e., the gross interest income less the expenditure incurred for earning
such income ? A related question, in the event it is held that the terms connote
netting of interest, is should netting be allowed where the interest income is
computed as business income ?

1.4 The issue believed to be settled by the decision of the
Special Bench of the ITAT in the case of Lalsons, 89 ITD 25 (Delhi) became
controversial due to the decisions of the Madras and Punjab and Haryana High
Courts. Again, these decisions of the High Court were not followed by the
decision of the Delhi High Court, upholding the ratio of the Lalsons’ decision.
The peace prevailing thereafter has been short-lived in view of the recent
decision of the Bombay High Court, dissenting form the decision of the Delhi
High Court.

2. Shri Ram Honda Equip’s case :

2.1 The issue arose for consideration of the Delhi High Court
in Shri Ram Honda Power Equip, 289 ITR 475 wherein substantial questions of law
concerning the interpretation of S. 80HHC, Ss. (1) and (3) and clause (baa) of
the Explanation, were raised before the High Court as under :

(a) Does the expression ‘profits derived from such export’
occurring in Ss.(3) r/w Expln. (baa) restrict the profits available for
deduction in terms of Ss.(1) to only those items of income directly relatable to
the business of export ?

(b) Does the expression ‘interest’ in Expln. (baa) connote
net interest, i.e., the gross interest income less the expenditure
incurred by the assessee for earning such income ?

(c) If the expression ‘interest’ implies net interest, then
should netting be allowed where the interest income is computed to be business
income ?

2.2 The two broad issues identified by the Court from the
three questions referred to it were the determination of the nature of interest
income and the issue of netting of interest. The Court noted that the first step
was to determine whether in a given case the income from interest was assessable
as a ‘business income’, computed in terms of S. 28 to S. 44, or as an ‘income
from other sources’ determined u/s.56 and u/s.57 and to ascertain thereafter,
whether while deducting ninety percent of interest therefrom in terms of Expln.
(baa), gross or net interest should be taken in to account.

2.3 It was contended on behalf of the assessee that profits cannot be arrived at by any businessman without accounting
for the expenditure incurred in earning such interest; that the entire clause
(baa) had to be read along with the scheme of S. 80HHC(1) and (3) and given a
meaning that did not produce absurd results; that the interpretation should
reflect a liberal construction conforming to the object of encouraging exports;
that use of the term ‘included in such profits’ following the words ‘brokerage,
commission, interest, rent, charges or any other receipts of a similar nature’
was indicative that such amounts were the ‘net’ amounts and only net interest
was includible in the profits; hence once interest income had been computed as
business income, then netting had to be allowed.

2.4 It was further urged that as per the mandate of clause
(baa) the profits and gains of business or profession had to be first computed
as per S. 28 to S. 44, including S. 37, which envisaged accounting for the
expenditure incurred by an assessee for earning the income. The assessees also
relied on paragraph 30.11 of Circular No. 621, dated. 19-12-1991 which provided
for ad hoc 10 percent deduction to account for the expenses. It was
further urged that the Legislature wherever desired had used the expression
‘gross’ as in S. 80M, S. 40(b), S. 44AB, S. 44AD and S. 115JB, making it clear
that the Legislature in terms of S. 80HHC intended that the interest to be
accounted for in computing the profits should be net interest; that the language
of the Section was unambiguous and therefore there was no need to supply the
word ‘gross’ as qualifying the word ‘interest’. Therefore, applying the same
rule of causus omissus, such word could not be read into the Section.
Reliance was placed on the decision in Distributors (Baroda) (P) Ltd., 155 ITR
120 (SC).

2.5 On the issue of netting, it was submitted on behalf of
the Revenue that even where the interest income was determined to be business
income, netting should not be permitted; that there could be no casus omissus,
in other words, the Court ought not to supply words when none exist; that just
as the assessees argued the Legislature if intended would have used the term
‘net’ and would have said so and in the absence of such a clear enunciation, the
word ‘interest’ has to be interpreted to mean ‘gross interest’; that applying
the strict rule of construction in interpreting the statutes, the expression
‘interest’ occurring in clause (baa) could only mean gross interest and that the
treatment in either case should be uniform.

2.6 On behalf of the Revenue it was further urged that the Legislature had permitted the retention of 10% of interest income to compensate for expenses laid out for earning such income, therefore any further deduction of the expenditure incurred for earning such interest, if permit-ted, would amount to a double deduction which clearly was not envisaged; that clause (baa) of the Explanation to S. 80HHC envisaged a two-step process in computing profits derived from exports, first, the AO was required to apply S. 28 to S. 44 to compute the profits and gains of business or profession. In doing so, the AO might find that certain incomes, which had no nexus to the ex-port business of the assessee, were not eligible for deduction and therefore ought to be treated as income from other sources. Once that was done, then 90% of the receipts referred in clause (baa) had to be deducted in order to arrive at the profits derived from profits. Reliance was placed on the decision of K. Venkata Reddy v. CIT, 250 ITR 147 (AP) in support of this submission. Even if the interest earned was to be construed as part of the business income, the netting should not be permitted since the statute did not specifically say so relying on the judgments in IPCA Laboratory Ltd. v. Dy. CIT, 266 ITR 521 (SC), CIT v. V. Chinnapandi, 282 ITR 389 (Mad.) and Rani Paliwal v. CIT, 268 ITR 220 (P & H).

2.7 The Delhi High Court found merit in the contention of the assessee that not accepting that interest in the context referred to net interest, might produce unintended or absurd results. The Court referring to the decision of Keshavji Ravji & Co. v. CIT, 183 ITR 1 (SC) highlighted that the underlying principle of netting appeared to be logical as no prudent businessman would allow taxation of the interest income de hors the expenditure incurred for earning such income. The words ‘included in such profits’ following the words ‘receipts by way of interest, commission, brokerage, etc.’, was a clear pointer to the fact that only net interest would be includible in arriving at the business profit; once business income had been determined by applying accounting standards as well as the provisions contained in the Act, the assessee would be permitted to, in terms of S. 37, claim as deduction, expenditure laid out for the purposes of earning such business income. The Court noted with approval the proposition for netting of income found from Circular No. 621, dated 19-12-1991 of the CBDT.

2.8 The Court observed that object of S. 80HHC was to ensure that the exporter got the benefit of the profits derived from export and was not to depress the profit further; if the deduction of 90% was of the gross interest itself, the amount spent in earning such interest would depress the profit to that extent by remaining on the debit side of the P&L Account; therefore, it could only be the net interest which could be included in the profits; if netting were not to be permitted, the result would be that the profits of the exporter would be depressed by an item that was expenditure incurred on earning interest, which did not form part of the profit at all; such could not have been the intention of the Legislature.

2.9 The Court did not approve of the contention that the treatment of clause (a) of S. 80HHC(3) should be no different from clause (b) of the same sub-section as the said clause (baa) was relatable only to clause (a) of S. 80HHC(3) and not to clause thereof; the provisions operated in distinct areas and no inter-mixing was contemplated.

2.10 For all these reasons, the Court held that the word ‘interest’ in clause (baa) to the Explanation in S. 80HHC was indicative of ‘net interest’, i.e., gross interest less the expenditure incurred by the assessee in earning such interest. The Court affirmed the decision of the Special Bench of the ITAT in Lalsons Enterprises (supra) holding that the expression ‘interest’ in clause (baa) of the Explanation to S. 80HHC connoted ‘net interest’ and not ‘gross interest’.

2.11 The Court noted that in deciding the issue in Rani Paliwal’s case (supra), the Punjab & Haryana High Court, without any detailed discussion simply upheld the Tribunal’s order and therefore did not follow the ratio of the said decision in these words: “We are afraid that there is no reasoning expressed by the High Court for arriving at such a conclusion. For instance, there is no discussion of the CBDT Circular and in particular para 32.11 thereof which indicates that netting is contemplated in Expln. (baa). Also, it does not notice the effect of the words ‘included in such profits’ following the words ‘receipts by way of interest….’ in the said Explanation. We are therefore unable to subscribe to the view taken by the Punjab & Haryana High Court in Rani Paliwal (supra).” The Court accordingly differed with the views of the Punjab & Haryana High Court in Rani Paliwal’s case.

2.12 While differing with the decision of the Madras High Court in Chinnapandi’s case, the Court observed as under: “The Madras High Court in CIT v. V. Chinnapandi (supra) held that even where the interest receipt is treated as business income, the deduction within the meaning of Expln. (baa) is permissible only of the gross interest and not net interest. The High Court appears to have followed the earlier judgment in K. S. Subbiah Pillai & Co. (supra) without noticing that in K. S. Subbiah Pillai (supra), the interest receipt was treated as income from other sources and not as business income. Also, the High Court in V. Chinnapandi (supra) chose to follow Rani Paliwal (supra), which, as explained earlier, gives no reasoning for the conclusion therein. Also, V. Chinnapandi (supra) does not advert to either the CBDT Circular or the judgment of the Special Bench in Lalsons (supra), with which we entirely concur on this aspect.”

2.13 The Court accordingly held that the net interest i.e., the gross interest less the expenditure incurred for the purposes of earning such interest, in terms of Expln. (baa), only be reduced from the profits of the business in cases where the AO treated the interest receipt as business income.

Asian Star Co. Ltd.’s case:

3.1 Recently the issue again arose before the Bombay High Court in the case of CIT v. Asian Star Ltd. in appeal No. 200 of 2009. In a decision delivered on March 18/19, 2010 the Court was asked to consider the following question of law:

“Whether on the facts and in the circumstances of the case and in law, the Tribunal was correct in holding that net interest on fixed deposits in banks received by the assessee-company should be considered for the purpose of working out the deduction u/s.80HHC and not the gross interest?”

3.2 The assessee carried on the business of the export of cut and polished diamonds. A return of income for A.Y. 2003-04 was filed, declaring a total income of Rs. 13.91 crores, after claiming a deduction of Rs.13.22 crores u/s.80HHC. The assessee had debited an amount of Rs. 21.46 crores as interest paid/payable to the Profit and Loss Account net of interest received of Rs. 3.25 crores. The assessee was called upon to explain as to why the deduction u/s.80HHC should not be recomputed by excluding ninety percent of the interest received in the amount of Rs.3.25 crores. By its explanation, the assessee submitted that during the year, it received interest on fixed deposits. The assessee stated that it had borrowed monies in order to fulfil its working capital requirements and the Bank had called upon it to maintain a fixed deposit as margin money against the loans. The assessee consequently contended that there was a direct nexus between the deposits kept in the Bank and the amounts borrowed.

3.3 The Assessing Officer, found that the explanation of the assessee could not be accepted since a plain reading of Explanation (baa) to S. 80HHE suggested that ninety percent of the receipts on account of brokerage, commission, interest, rent, charges or receipts of a similar nature were liable to be excluded while computing the profits of the business. In appeal, the CIT (Appeals) held that the assessee had established a direct nexus between interest-bearing fixed deposits and the ‘interest charging’ borrowed funds and he directed the Assessing Officer to allow the netting of interest income and interest expenses. The view of the CIT (Appeals) was confirmed in appeal by the Income-tax Appellate Tribunal. The Tribunal held that the finding of the Appellate Authority was based on the existence of a nexus between borrowed funds and fixed deposits. The Tribunal followed its decision in the case of Lalsons Enterprises, 89 ITD 25 (Delhi).

3.4 The Revenue contended that for computing the profits and gains of the business for S. 80HHC, ninety percent of the receipts by way of interest had to be reduced from the profits and gains of business or profession and the ‘receipts’ to be so reduced were the gross receipts; consequently, the gross receipts by way of interest could not be netted against expenditure which was laid out for the earning of those receipts; the reduction provided by the law was independent of any expenditure that was incurred in the earning of the receipts; that non -operational income should be excluded as it had no nexus with the export turnover, while on the other hand, it depressed profits by including expenditure which had been incurred for those very items which led to a consequence which could not have been intended by the Parliament having regard to the beneficial object underlying the provision.

3.5 The summary of the assessee’s contentions was that (i) The words ‘any receipts’ denoted the nature and not the quantum of the receipt;
The expression, therefore, required the nature of the receipts to be examined; (iii) Explanation (baa) referred to any receipts of a similar nature ‘included in such profits’. The words ‘such profits’ meant profits and gains of business or profession computed u/s.28 to u/s.44D; (iv) Profits could only be arrived at after the deduction of expenditure from income and the net effect thereof constituted profits; (v) Explanation (baa) did not use the expression ‘gross or net’. However, having regard to the purpose and object of the provision and the nature of the language used in the Explanation, ninety percent of the receipts that was required to be excluded had to be computed with reference to inclusion of such receipts in profits and gains of business which in turn involved both credit and debit sides of the profit and loss account; (vi) For purposes of Explanation (baa), income from other sources would not come within the purview of the Explanation; Only business income had to be considered and interest in the nature of business income had to be taken into consideration; (vii)Receipts by way of interest in Explanation (baa) denoted the nature of the receipts and inclusion in ‘such profits’ would denote the quantum of the receipts; (viii) The words used by the Legislature suggested what was included in the total income or had gone into the computation of total income. Consequently, both debit and credit sides of the profit and loss account would have to be consid-ered; (ix) The words ‘such profits’ could only mean such profits as computed in accordance with the provisions of the Act; (x) The words ‘receipt’ and ‘income’ in Explanation (baa) were interchangeably used and consequently, receipts would have to be read as income; (xi) The correct interpretation was to take into consideration netting and exclude all expenses which had a direct nexus with the earning of the income; (xii) The provision being an incentive provision under Chapter VIA, must be beneficially construed in order to encourage exports; (xiii)

The word ‘profits’ denoted profits in a commercial sense; (xiv) the object of the exclusion contained in Explanation (baa) was to sequester certain non-operational income which did not bear a direct nexus with export income and as a consequence, the exclusion could not be confined only to credit side of the profit and loss account, but must extend equally to the debit side, subject to the rider that a clear nexus has to be established.

3.6 The Bombay High Court explaining the rationale underlying the exclusion noted that : Ss.(3) of S. 80HHC was inserted by the Finance Act of 1991, with effect from 1st April 1992; the adoption of the formula in Ss.(3) was to disallow a part of the concession when the entire deduction claimed could not be regarded as being derived from export; S. 80HHC had to be amended several times since the formula had resulted in a distorted figure of export profits where receipts such as interest, rent, commission and brokerage which did not have a direct nexus with export turnover were included in the profit and loss account and resultantly became a subject of deduction; by the amendment, the position that emerged was that receipts which did not have any element of or nexus with export turnover would not become eligible for deduction merely because they formed part of the profit and loss account; this aspect of the history underlying S. 80HHC, had been elaborated upon in the judgment of the Supreme Court in the case of CIT v. Lakshmi Machine Works, 290 ITR 667.

3.7 The Court further noted that; the Explanation (baa) had to be read in the context of the background underlying the exclusion of certain constituent elements of the profit and loss account from the eligibility for deduction; what Explanation (baa) postulated was that, in computing the profits of business for S. 80HHC, the profits of business had to be first computed under the head profits and gains of business or profession, in accordance with S. 28 to S. 44D; once that exercise was complete, those profits had to be reduced to the extent provided by clauses (1) and (2) of Explanation (baa); that such receipts by way of brokerage, commission, interest, rent, charges or other receipts of a similar nature, though included in the profits and gains of business or profession, did not bear a nexus with the export turnover and consequently, though included in the computation of profits and gains of business or profession, ninety percent of such receipts had to be excluded in computing the profits of business for S. 80HHC; the reason for the exclusion was borne out by the Circular issued by the CBDT on 19-12-1991 which noted that the formula then existing often presented a distorted figure of export profits when receipts like interest, commission, etc. which did not have an element of turnover were included in the profit and loss account; the Court was required to give a meaning to the provision consistent with the underlying scheme, object and purpose of the statutory provision; the Parliament considered it appropriate to exclude from the purview of the deduction u/s.80HHC, certain receipts or income which did not have a proximate nexus with export turnover though such items formed part of the profit and loss account and form a constituent element in the computation of the profits or gains of business or profession u/s.28 to u/s.44D. The interpretation which Court placed on the provisions of S. 80HHC and on Explanation (baa) must be consistent with the law laid down by the Supreme Court in the cases of CIT v. K. Ravindranathan Nair, 295 ITR 228 295 ITR 228 where the Supreme Court held that processing charges, though a part of gross total income constituted an item of independent income like rent, commission and brokerage and consequently, ninety percent of the processing charges had to be reduced from gross total income to arrive at business profits, and Lakshmi Machine Works (supra) where the issue before the Supreme Court was whether excise duty and sales tax were included in the total turnover for the purpose of working out the formula contained in S. 80HHC(3) and the Supreme Court held that the object of the Legislature in enacting S. 80HHC was to confer benefit on profits accruing with reference to export turnover and the Supreme Court in that case had observed that ‘commission, rent, interest, etc. did not involve any turnover’ and ‘therefore, ninety percent of such commission, interest, etc. was excluded from the profits derived from?the?export,’?just?as?interest, commission, etc. did not emanate from export turnover, so also excise duty and sales tax had to be excluded.

3.8 The Court explained the resultant position in law as that while prescribing the exclusion of the specified receipts the Parliament was, however, conscious of the fact that the expenditure incurred in earning the items which were liable to be excluded had already gone into the computation of business profits as the computation of business profits under Chapter IV is made by amalgamating the receipts as well as the expenditure incurred in carrying on the business; since the expenditure incurred in earning the income by way of interest, brokerage, commission, rent, charges or other similar receipts had also gone into the computation of business profits, the Parliament thought it fit to exclude only ninety percent of the receipts received by the assessee in order to ensure that the expenditure which was incurred by the assessee in earning the receipts which had gone into the computation of the business profits is taken care of; the reason why the Parliament confined the reduction factor to ninety percent of the receipts was stated in the Memorandum explaining the provisions of the Finance Bill of 1991; the Parliament, therefore, confined the reduction to the extent of ninety percent of the income earned through such receipts since it was cognizant of the fact that the assessee would have incurred some expenditure in earning those incomes and therefore it provided an ad hoc deduction of ten percent from such incomes to account for the expenses incurred in earning the receipts; the distortion of the profits that would take place by excluding the receipts received by the assessee which were unrelated to export turnover and not the expenditure incurred by the assessee in earning those receipts was factored in by the Parliament by excluding only ninety percent of the receipts received by the assessee; the Parliament thought it fit to adopt a uniform formula envisaging a reduc-tion of ninety percent to make due allowance for the expenditure which would have been incurred by the assessee in earning the receipts, though in a given case it might be more or less as it was considered to be reasonable parameter of what would have been expended by the assessee; in order to simplify the application of the law, the Parliament treated a uniform expenditure computed at ten percent to be applicable in order to ensure that there is no distortion of profits by exclusion of income not relatable to export profits.

3.9 In view of the objective of the Parliament behind the introduction of the Explanation (baa) and its desire to provide uniformity of the treatment and the fact that the deduction of S. 80HHC was related to export turnover, the Bombay High Court held that the ratio and the findings of the Supreme Court in the case of the Distributors (Baroda) P. Ltd. v. Union of India, 155 ITR 120 were not relevant in the context of the issue under consideration by the Court; it was in order to obviate a distortion that the Parliament mandated that ninety percent of the receipts would be excluded; consequently, while the principle which had been laid down by the Supreme Court in Distributors (Baroda)’s case must illuminate the interpretation of the words ‘included in such profits’, the Court could not, at the same time, be unmindful of the reduction which was postulated by Explanation (baa), the extent of the reduction and the rationale for effecting the reduction.

3.10 The Bombay High Court noted with approval the decisions of the High Courts in the cases of K. S. Subbiah Pillai & Co. (India) Pvt. Ltd. v. CIT, CIT v. V. Chinnapandi, Rani Paliwal v. CIT and CIT v. Liberty Footwears. In view of number of reasons advanced and after a careful consideration the Bombay High Court was not inclined to follow the judgment of the Division Bench of the Delhi High Court in CIT v. Shri Ram Honda Power Equipments as the simi-larity between the provisions of S. 80HHC and S. 80M which was relied upon in the judgment of the Delhi High Court missed the comprehensive position as it obtained u/s.80HHC.Such similarity of the provisions should not result into an assumption that the provisions were identical, when they were not as the Parliament had adopted a fair and reasonable statutory basis of what may be regarded as expenditure incurred for the earning of the receipts. Once the Parliament had legislated both in regard to the nature of the exclusion and the extent of the exclusion, it would not be open to the Court to order otherwise by rewriting the legislative provision. The Court observed with respect that the Delhi High Court had not adequately emphasised the entire rationale for confining the deduction only to the extent of ninety percent of the excludible receipts.

3.11 The displeasure of the Bombay High Court with the decision of the Special Bench in Lalsons Enterprises’s case, can best be explained in the Court’s own words “We are affirmatively of the view that in its discussion on the issue of netting, the Tribunal in its Special Bench decision in Lalsons has transgressed the limitations on the exercise of judicial power. The Tribunal has in effect, legislated by providing a deduction on the ground of expenses other than in the terms which have been allowed by the Parliament. That is impermissible. In the present case, it is necessary to emphasise that the question before the Court relates to the deduction u/s.80HHC. An assessee may well be entitled to a deduction in respect of the expenditure laid out wholly and exclusively for the purpose of business in the computation of the profits and gains of business or profession. However, for the purposes of computing the deduction u/s.80HHC, the provisions which have been enacted by the Parliament would have to be complied. A deduction in excess of what is mandated by the Parliament cannot be allowed on the theory that it is an incentive provision intended to encourage export. The extent of the deduction and the conditions subject to which the deduction should be granted, are matters for the Parliament to legislate upon. The Parliament having legislated, it would not be open to the Court to deviate from the provisions which have been enacted in S. 80HHC.”

3.13 The Bombay High Court allowed the appeal of the Revenue by holding that the Tribunal was not justified in coming to the conclusion that the net interest on fixed deposits in the bank received by the assessee should be considered for the purposes of working out the deduction u/s.80HHC and not the gross interest.

4.Observations:

4.1 The issue has been clearly identified and argued and is further highlighted by sharply contrasting views of the High Courts on the subject. The Apex Court alone can bring finality to this fiercely contested issue.

4.2 As we understand from the reading of the Bombay High Court decision, the case of an exporter for netting of interest, etc. having nexus with the export activity is fortified. It is in cases where such receipts have no nexus with the export activity that a shadow of serious doubt has been cast by the recent decision of the Bombay High Court.

4.3 In bringing a finality to the issue, in addition to the issues which are very succinctly brought to the notice of the Courts by the contesting parties, the following aspects will have to be conclusively adjudicated upon;

4.3.1 While in a good number of cases, it maybe true that the ends of the justice will be met by allowing a deduction of 10% of the income, such a benchmark will be found to be woefully inad-equate in cases where the activity is conducted in an orderly manner, as a business. For example, a broker or a commission agent paying a sizeable amount to a sub-broker or sub-agent or lender of funds advancing loans out of borrowed funds bearing interest. In the examples given, the expenditure surely would exceed the benchmark of 10% of income. The allowance of 10% of income, in such cases, cannot be considered to be reasonable by any standard. In such cases, at least, it will be fair to read that the receipt in question is the net receipt, more so as in the cases of person who had accounted only net receipt in the books.

4.3.2 The allowance of any direct expenditure may have always been presumed and it is for avoiding any controversy in relation to an indirect expenditure that the 10% allowance is granted by the Legislature.

4.3.3 The direct expenditure, if not allowed, will give absurd results inasmuch as the same has the effect of depressing the export profit, otherwise eligible for deduction. If such receipts were to be taken out of the business profits on the footing that they had no connection with the business profits or turnover, it would only be reasonable to hold that expenditure having nexus with such receipts should also be taken out of the business profits on the same footing.

4.3.4 The result surely will be different in case where the assesssee is found to have maintained separate books of account or where the accounting is net of direct cost.

4.3.5 The result will also be different in cases where the assessee on his own had treated the receipt as also the income under a separate head of income.

4.3.6 It is an accepted principle of interpretation that the law has to be read in the context in which has placed. RBI v. Peerless General Finance Investment Co. Ltd., 61 Comp Case 663. The Delhi High Court clarified that it was inclined to adopt this contextual approach further enunciated by the Madras High Court in CIT v. P. Manonmani, 245 ITR 48 (Mad.) (FB). The context in which the word ‘receipt’ is used in Expln. (baa) may mean such receipts as reduced by the expenditure laid out for earning such income. The possible way to reconcile this is as was done by the Delhi High Court by reading the expression ‘receipts by way of brokerage, commission, interest….’ as referring to the nature of receipt, which in the context of S. 80HHC connotes ‘income’.

4.3.7 Paragraph 32.10 of Circular No. 681, dated 19-12- 1991 reads as under: “The existing formula often gives a distorted figure of export profits when receipts like interest, commission, etc., which do not have element of turnover are included in the P&L Account. It has, therefore, been clarified that ‘profits of the business’ for the purpose of S. 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10% deduction from such incomes is provided to account for these expenses.”

4.3.8 Circular No. 621 explained the provisions of the amendment and in so explaining has favoured netting, as has been highlighted by the Delhi High Court. If that is so, the full effect, though benefi-cial, shall be given to such interpretation advanced by the Circular of the CBDT in preference to the Notes and the Memorandum. Full effect may be given to the above-referred CBDT Circular which acknowledges that ‘receipts by way of brokerage, commission, interest’, etc., are ‘incomes’ and in order to give effect to this expression, the principle of netting will have to be applied.

4.3.9 Due weightage will have to be given to the true meaning of the words ‘included in such profits’ which precede the words ‘receipts by way of brokerage, commission and interest’.

4.3.10 The ratio of the decision of the Constitutional Bench of the Supreme Court in the case of Distributors (Baroda) (P) Ltd., though considered by the Courts, will have to be revisited in order to conclusively appreciate the meaning of the words and the expressions ‘receipts by way of’ ‘included in such profits,’ ‘such profits’ and ‘computed in accordance with the provisions of the Act’.

4.3.11 The three different expressions, namely, ‘any sums’, ‘receipts’ and ‘profits’, used by the Parliament will have to be reconciled.

4.4 This controversy has plagued a good number of cases and it will be in the fitness of the things that the Government adopts a reconciliatory approach and issues a dispensation or a directive for addressing the issue that does not clog the wheels of justice.

Nirav Shah

Business Combinations

Nirav Shah

ICAI’s announcement on accounting for derivatives – Practical issues and challenges

Accounting Standards

Application of AS-30, Financial Instruments: Recognition and
Measurement is recommendatory from 1-4-2009 and mandatory from 1-4-2011.
However, in the meanwhile various regulatory authorities were concerned about
the manner in which derivative losses were being accounted for. To ensure that
losses on account of exposure to derivatives are duly provided in financial
statements, the ICAI has recently issued an Announcement on accounting of
derivatives. The Announcement is applicable to all derivatives except for
forward exchange contracts covered under AS-11, The Effects of Changes in
Foreign Exchange Rates. The Announcement applies to financial statements for the
period ending on or after 31 March, 2008. The Announcement prescribes following
accounting guidance for derivatives :

• Entities should do accounting for all derivatives in
accordance with AS-30. In case AS-30 is followed by the entity, a disclosure
of the amounts recognised in the financial statements should be made.

• In case an entity does not follow AS-30, the entity
should mark-to-market all the outstanding derivative contracts on the balance
sheet date. The resulting mark-to-market losses should be provided for keeping
in view the principle of prudence as enunciated in AS-1, Disclosure of
Accounting Policies.

• The entity should disclose the policy followed with
regard to accounting for derivatives in its financial statements.

• In case AS-30 is not followed, the losses provided for
should be separately disclosed by the entity.

• In case of derivatives covered under AS-11, that standard
would apply.

• The auditors should consider making appropriate
disclosures in their reports if the aforesaid accounting treatment and
disclosures are not made.

The objective of ICAI in providing clarification on
accounting for derivative is to ensure that financial statements reflect a true
and fair picture of the financial position. The Announcement comes at the fag
end of the financial year and leaves very little time for corporates to
implement it. Derivative deals are complex and companies will require time to
ensure proper fair valuation of such contracts.

Accounting Standards are required to be notified under the
Companies (Accounting Standard) Rules, 2006. In the absence of the Announcement
being notified under the Act, the question of its legal validity arises.
Companies may argue that they are not bound to comply with accounting treatment
prescribed in the Announcements. However, auditors are required to qualify the
accounts, if an ICAI Announcement is not followed. Companies wanting to avoid a
qualification from the auditor are indirectly forced to comply. The Announcement
therefore creates a surrogate rather than a legal requirement for companies to
follow. The author believes that due process of law has been by-passed.

The Announcement prescribes that accounting for derivatives
can be done in accordance with AS-30. Should AS-30 be early adopted in its
entirety or is the early adoption limited to accounting principles relating to
derivatives and hedge accounting ? AS-30 is not yet notified in the Companies
(Accounting Standard) Rules, 2006. If AS-30 has to be adopted in its entirety,
it will conflict with some existing accounting standards notified in the
Companies (Accounting Standards) Rules, 2006, such as accounting for investments
under AS-13 and accounting for forward contracts under AS-11. On the other hand,
AS-30 cannot be applied selectively for derivative and hedges, since it
contradicts the requirement of the Indian GAAP framework which prohibits
selective application of standards. This dichotomy is insoluble.

The Announcement is based on the framework of ‘Prudence’. If
prudence is all that it takes to make financial statements true and fair, then
it begs the question, why does one need any other accounting standards ? AS-30
requires recognition of unrealised gains on derivatives as well. So also, under
AS-11, speculative contracts are marked to market and both gains and losses are
recognised. Therefore as can be seen ‘Prudence’ has been overtaken by the
framework of ‘fair valuation’. If fair value is the framework that is the
cornerstone of future accounting standards, it is illogical to issue an
Announcement based on the concept of ‘Prudence’.

The Announcement is not applicable to forward exchange
contracts covered under AS-11. To determine whether a particular derivative
contract is covered under scope of AS-11 or the announcement, it is crucial to
decide whether such derivative contract is in substance a forward exchange
contract. AS-11 defines forward exchange contract as ‘an agreement to exchange
different currencies at a forward rate’. Forward rate is defined as ‘the
specified exchange rate for exchange of two currencies at a forward rate’.
Paragraph 36 of AS-11 also states “An enterprise may enter into a forward
exchange contract or another financial instrument that is in substance a forward
contract, which is not intended for trading or speculation purposes, to
establish the amount of the reporting currency required or available at the
settlement date of a transaction”. Considering the definition of forward
contracts, it would be easy to conclude in case of derivative instruments like
plain vanilla USD-INR forward contract undertaken to hedge USD receivable is
covered under AS-11. However, whether a purchase option, written option or
option with exotic features such as knock-in-knock-out, range options, etc.
would be within the scope of AS-11 is a question mark.

The Announcement states “In case an entity does not follow
AS-30, keeping in view the principle of prudence as enunciated in AS-1 the
entity is required to provide for losses in respect of all outstanding
derivative contracts at the balance sheet date by marking them to market”. There
is no guidance given in the Announcement regarding how such losses should be
computed. Theoretically, following options are possible : (a) losses can be
computed on each contract basis (b) losses can be computed based on portfolio
basis — net loss is determined for each category of derivatives such as option
contracts or commodity contracts (c) losses can be computed on global-company
basis — net loss on entire portfolio of derivatives taken together. Guidance is
also needed on whether losses should be calculated considering fair value
changes in the derivatives only or whether offsetting gain on the hedged item
can be considered for determining net losses.

The Announcement does not clarify whether losses on embedded derivatives need to be provided or not. A corporate may incorporate a stand-alone derivative in another host contract and try to avoid recognition of losses on the derivatives.

The Announcement requires provision for mark-to-market losses. Many of the derivative instruments are proprietary products of banks, which do not have any ready market. Therefore such derivatives are rather marked to a model, which is usually bank-specific, rather than marked-to-market. Fair valuation of derivatives, particularly long-term derivatives, is likely to be highly subjective, since it would involve considerable extrapolation. In many cases such long-term judgments do not match with the actual situation that emerges later. Hence fair valuation of illiquid instruments tends to be very unreliable. In a survey done by Ernst & Young, it was found that stock option expense as a percentage of reported results could vary as much as 40% to 155% by just tinkering with the assumptions, but within the boundaries of the Standard.

The whole issue of whether these contracts are wagering contracts is something that will be eventually settled in the court of law. It is probably too early to say if the liability will eventually devolve on the corp orates or on the bank. Neither does the Announcement cover these uncertainties, nor does it clearly state if what is being dealt with are only foreign exchange derivatives or all types of derivatives.

From the above it is evident that there are various complex issues in the implementation of the Announcement, which ICAI needs to clarify. Unless clarity is provided on the above issues, various companies will follow different accounting policies to compute losses on derivative contracts. This will hamper comparability and result in subjectivity and inconsistency in accounting for derivatives. The ICAI should defer the applicability of the Announcement till the time clarity on the above-mentioned issues is provided to the Industry. In the meanwhile, the requirement should be restricted to disclosure of derivative losses only. ICAI may also consider advancing the 2011 mandatory date for AS-30 to 2009.

Nirav Shah

Substantive Analytical Procedures: Relevance and Efficacy in an Audit

During the course of an audit of financial statements, an auditor is required to obtain sufficient and appropriate audit evidence to ensure that the financial statements are not materially misstated. The procedures adopted for this purpose are enquiry, observation, testing and re-performance. The procedures around testing involve testing of controls as well as test of details. The test of details may comprise of substantive testing or use of substantive analytical procedures (SAPs) or a combination of both.

SAP procedures consist of evaluating financial information through analysis of plausible relationships among both financial and non-financial data. It also consists of investigation of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. The basic presumption behind the use of SAP by an auditor is that correlation between data can be expected to exist in the absence of any condition either financial or non-financial disturbing such relationship. However it is to be noted that while performing any form of SAP, prior knowledge of the industry in which the entity operates is very crucial along with the understanding the efficiencies and limitations that are harbored in adapting such procedures. SAP are subject to auditor judgment including evaluation of the data to be used and understanding the conclusions reached.

SAP may be performed using various methods like statistical techniques and Computer Assisted Audit Techniques (“CAAT’s”). They can be performed at financial caption level or at a disaggregated detailed level of information. The auditor may choose to apply SAP on financial statements as a whole or on any specific component of the financial statements. The decision about which audit procedures to perform, including whether to use SAP, is based on the auditor’s experience about the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion level to an acceptably lower level.

SAP are generally used by the auditor at the following stages of audit:

Risk assessment procedures (termed as planning SAP) which assist the auditor in identifying and assessing the risks of material misstatement thus allowing them to provide a basis for designing and implementing the audit procedures. For instance – revenue trend analysis, gross margin analysis, effective tax rate reconciliation, etc.

Substantive procedures (termed as SAP) to obtain corroborative audit evidence about relevant assertions and the risks attached to such assertions. For instance, payroll logic test, interest costs as a percentage of borrowings, etc.

Final analytical procedures – to perform an overall review of the financial statements (termed as final SAP) to aid the auditor while forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity and its business.

Suitability of a particular analytical procedure for a given assertion:

SAP are generally more applicable to large volumes of transactions that tend to be predictable over time. However, the suitability of a particular analytical procedure will depend upon the auditor’s assessment of how effective it will be in detecting a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated. Different types of SAP provide different levels of assurance.

For example building up an expectation of payroll cost (as demonstrated in the case study discussed later) can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the information used and the elements of the payroll cost is appropriately tested.

On the other hand, calculation and comparison of effective tax rate to profit before tax can be deemed as a means of confirming the completeness of tax provision, however this will provide less persuasive evidence, but may be reduce the detail of work that needs to be performed for other audit steps performed on the caption.

It is imperative that the auditor has adequate assurance over the efficacy of the internal controls around over financial reporting of an enterprise before he concludes to place reliance solely on analytical procedures to get comfort over any financial statement caption.

Reliability of data

Before placing reliance on the assurance obtained from SAP the auditor needs to evaluate and confirm the data used to perform SAP. The reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Some of the parameters that may be considered by an auditor to evaluate the reliability of the data are:

i. Source of the information available, for instance, information may be more reliable when it is obtained from independent sources outside the entity.

ii. Comparability of the information available, for instance, information from the same industry may be more reliable than information of the entities operating in the cluster of industries.

iii. Nature and relevance of the information available. For example, whether budgets have been established as results to be expected rather than as goals to be achieved; and

iv. Controls over the preparation of the information that are designed to ensure its completeness, accuracy and validity. For example, controls over the preparation, review and maintenance of accounting information. The auditor may choose to test the operative effectiveness of controls over preparation of data giving him further assurance on the reliability of the data used to perform SAP.

While devising substantive analytical procedures, an auditor considers comparison of the entity’s financial information with:

Comparable information of the prior period for the caption on which assurance is planned to be achieved through SAP.

Anticipated results of the entity including budgets and forecasts made by the management.

Expectations made by the auditor, for example – comparing actual with estimated lease rent or an estimation of depreciation.

Information of the industry in which the entity operates – for instance, the comparison of the debtors’ turnover ratio of the enterprise with that of the industry to identify nuances in the entity’s operating cycle, industry growth with sales growth of the enterprise.

The auditor also considers relationships amongst the various elements of financial information to obtain assurance on the trend/variation in financial statement captions. An illustrative inventory of such relationships is as given below:

relationship between variation in turnover and debtors

variation in material cost consumption with variation in input prices, manufacturing yield, capitalization of new machinery, variation in cost of repairs of plant and machinery

correlation of variation in payroll costs with employee count, labor turnover

correlation between labor efficiency rates and production costs

variation in power and fuel consumption costs with variation in manufacturing output/power tariffs.

Let us understand SAP with the help of a practical example:

Background:

ABC India Private Limited (‘ABC’) is a service provider whose primary business is to act as customer care center for its clients. The business model involves setting up of a call center with relevant IT, telecommunication and other infrastructure facilities and hiring and training graduates with good communication skills who are required to attend to customer calls. As far as execution of services is concerned, the employee pyramid comprises of a large number of graduates, related proportion of supervisors/ team leaders and delivery heads. ABC also has a robust sales and marketing team. The company has signed agreements with various customers where its revenue is
based on an agreed charge-out rate and the number of executives requested for by the customer. the executives may be assigned on a 24×7 basis or otherwise depending on the customer requirements. The major expenses for ABC comprise of payroll cost.

Application of SAP on Payroll Cost

the auditor may use SaP to obtain evidence surrounding ‘C’ of salary costs. to start with the auditor would need to build up an expectation for the payroll cost. he may do so by using the average salary earned per employee and the average number of employees which were employed by the company during the year. he also needs to determine the amount of variance from the expectation so worked out with the actual cost which can be accepted without further investigation. This amount is influenced by the materiality, the assurance that is desired by the auditor while performing this analytical procedure and the assessed risk for the financial caption assertion. Let us assume that the auditor has set the amount of allowable difference as rs. 2 crore. he may arrive at his expectation of the salary cost as follows

Scenario 1:
The salary cost of the company as per the draft financials
is rs. 32.10 crore which is different than the salary cost as arrived by the auditor in his expectation. however the difference between the expectation i.e. rs. 31.26 crore and the actual cost (rs. 32.10 crore) is rs. 84 lakh which is within the limit of allowable difference set by the auditor. In such a situation the audit may choose not to perform any further scrutiny on the difference and conclude to have obtained the desired level of assurance from this procedure that he initially set out to obtain.

Scenario 2:
The salary cost of the company as per the draft financials is rs. 34.57 crore which is different than the salary cost as arrived by the auditor in his expectation. however the difference between the expectation i.e.rs. 31.26 crore and the actual cost (rs. 34.57 crore) is rs. 3.31 crore which is greater than the allowable difference set by the auditor during the commencement of this exercise.

In such a case the auditor would investigate into the reasons for the variance arrived at by him so as to bring the variance to an acceptable level. he may also chose to do further audit procedures on this caption to get the required level of assurance.

Some reasons for variance may be:

Joining of senior personnel in a band with salary far higher than average

Large number of joiners at month end or vice versa

Increment during the period for certain bands of employees, including mid-term increment

Exceptional/discretionary bonus or other payouts, etc.

Revision is statutory obligations such as percentage of provident fund/superannuation contribution, minimum wages payable under labor laws, changes in retiral benefits such as gratuity, basis of leave encashment

Revision in assumptions made for payroll liabilities which are actuarially valued such as pension, compensated benefits, gratuity, post medical retirement benefits etc.

After investigating the difference, the auditor may rebuild his expectation so as to take effect of the newly identified factors and modify his evaluation of the difference identified based on those factors.

In this case, the auditor may also be able to build up an expectation on the revenue for a reporting period for ABC as the revenue model is entirely based on the category of employees who have been assigned to customers. one could apply the agreed charge out rates on the average number of employees employed during a period and arrive at the expectation. a similar exercise of comparing and challenging the actual results against the actual results could provide insights on what further audit procedures need to be undertaken to obtain assurance on the revenue recognised during a given period.

Conclusion

Use of SAP during the planning, execution and completion stages of an audit enables an auditor to obtain sufficient and appropriate audit evidence to address the risk of material misstatement as also brings efficiencies in the audit process by way of reduced effort on substantive testing. Substantive analytical procedures provide the auditor with an overall perspective of the financial impact of significant events that have taken place in an enterprise during the reporting period. It could be said that SAP aids the auditor in setting the level of professional skepticism in terms of identifying areas where additional or detailed substantive testing may be required to be performed.

Nirav Shah

A. P. (DIR Series) Circular No. 104 dated 17th May, 2013

28. A. P. (DIR Series) Circular No. 104 dated 17th May, 2013

Foreign Direct Investment (FDI) in India – Issue of equity shares under the FDI scheme allowed under the Government route against pre-operative/pre-incorporation expenses

Presently, shares can be allotted to a foreign investor under the Approval Route of the FDI Scheme against payments made by him (the foreign investor) towards pre-operative/pre-incorporation expenses (including payments of rent, etc.) only if the payment is routed through the bank account of the investee company.

This circular has modified the said condition and provides that equity shares can be allotted to a for-eign investor under the Approval Route of the FDI Scheme against payments made by him (the foreign investor) towards pre-operative/pre-incorporation expenses (including payments of rent, etc.) if the payment is routed through the bank account of the investee company or the payment is made from the bank account opened by the foreign investor as provided under FEMA Regulations. The amended paragraph is as under: –

Nirav Shah

A. P. (DIR Series) Circular No. 103 dated 13th May, 2013

27. A. P. (DIR Series) Circular No. 103 dated 13th May, 2013

Import of Gold by Nominated Banks/Agencies

Presently, gold can be imported by the nominated banks/agencies on a consignment basis. Ownership of the gold will rest with the supplier and the nominated banks/agencies only act as agents of the supplier. Remittances towards the cost of import have to be made as and when sales take place.

This circular restricts the import of gold on consignment basis, by providing that banks can import gold on consignment basis, only to meet the genuine needs of exporters of gold jewellery.

Nirav Shah

Turnover and value of stock adopted by Sales Tax Authorities is binding on Income-tax Authorities: Addition merely on basis of statement of third parties is not proper:

20. Assessment: A. Y. 1998-99 to 2002-03:

Turnover and value of stock adopted by Sales Tax Authorities is binding on Income-tax Authorities: Addition merely on basis of statement of third parties is not proper:

CIT vs. Smt. Sakuntala Devi Khetan: 352 ITR 484 (Mad):

The assessee was a trader in turmeric. For the relevant assessment years the Assessing Officer made additions on the basis statement of third parties. The Tribunal directed the Assessing Officer to adopt the figures of turnover finally assessed by the Sales Tax Authorities and apply the GP rate accordingly.

On appeal by the Revenue, the following question was raised before the Madras High Court:

“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the turnover and profit of the assessee for the assessment year under consideration could not be computed in the reassessment on the basis of information received in the course of search conducted in certain cases on the sole ground that the Sales Tax Authorities have accepted the assessee’s purchases, sales and closing stock?”

The High Court upheld the decision of the Tribunal and held as under:

“i) Unless and until the competent authority under the Sales Tax Act differs or varies with the closing stock of the assessee, the return accepted by the Commercial Tax Department is binding on the Income -tax Authorities and the Assessing Officer has no power to scrutinise the return submitted by the assessee to the Commercial Tax Department and accepted by the Authorities. The Assessing Officer has no jurisdiction to go beyond the value of the closing stock declared by the assessee and accepted by the Commercial Tax Department.

ii) The assessee had placed the sales tax returns before the Assessing Officer in respect of the A. Ys. 1998-99 to 2001-02. Therefore, sufficient materials were placed before the Assessing Officer in respect of those assessment years and accepted by the Authorities.

iii) The Tribunal rightly found that the Department could not have made the addition merely on the basis of the statement of third parties and, consequently, set aside the order of the Commissioner (Appeals) and directed the Assessing Officer to adopt the figures of turnover finally assessed by the sales tax authorities and apply the gross profit rate accordingly.”

Nirav Shah

Contact details of Income Tax Ombudsman, at different Centres

Nirav Shah

TDS on Discount on Airline Tickets

Controversies

1. Issue for Consideration :

1.1 Airlines generally sell air tickets through travel
agents who are paid a commission on sale of such tickets which commission is
worked out on the basis of the minimum fares prescribed by the airlines. Tax
is deducted by the airlines on this commission u/s. 194H of the Act. Where the
tickets are provided to the travel agent by the airlines at a price below the
published fare, the difference, known as ‘discount’, or a part thereof is
retained by him while selling the tickets to the passengers, which is in
addition to the regular commission earned by him. No tax is deducted by the
Airlines on this amount retained by the travel agents. All airlines are
required to file a list of their standard fares with the Director General of
Commercial Aviation, which are called published fares. Usually tickets are
provided by airlines to travel agents at significant discounts to the
published fares and sold by the agents to their customers by passing over the
difference in full or part. Under IATA rules, the travel agents receive their
commission as a percentage of the published fares, in respect of which tax is
deducted at source by the airline under Section 194H.

1.2 S. 194 H defines ‘commission or brokerage’, vide
Explanation(i), as under :

” ‘Commission or brokerage’ includes any payment received
or receivable, directly or indirectly by a person acting on behalf of another
person for services rendered (not being professional services) or for any
services in the course of buying or selling of goods or in relation to any
transaction relating to any asset, valuable article or thing not being
securities.”

1.3 In recent years, tax authorities have sought to take a
stand that the discount from published fares given by airlines to travel
agents (which in turn is generally passed on by the travel agent to the
customer in full or part) amounts to an additional special commission, and
that TDS is deductible on this amount under Section 194H.

1.4 The issue has now reached Courts and the Bombay High
Court has held that such discount is not in the nature of brokerage or
commission and no tax is deductible thereon. The Delhi High Court has taken a
view that tax is deductible on such discount.

2. Qutar Airways’ case :

2.1 The issue came up before the Bombay High Court in the
case of CIT vs. Qutar Airways (Income Tax Appeal No.99 of 2009),
ITATOnline.org.

2.2 In this case, it had been claimed by the Revenue that
the difference between the published price and the minimum fixed commercial
price amounted to an additional special commission, and that TDS was therefore
deductible by the airline on this amount under Section 194H.

2.3 The Tribunal had granted relief to the airline,
following its earlier decision in the case of Korean Air vs. DCIT,
holding that TDS was not deductible in similar circumstances.

2.4 Before the Bombay High Court, the counsel for the
Revenue contended that it was not the Revenue’s case that the difference
between the principal price of the tickets (as published) and the minimum
fixed commercial price amounted to brokerage.

2.5 The Bombay High Court noted that though an appeal had
been preferred against the decision of the Tribunal in Korean Air’s case, the
appeal had been rejected by the High Court for non-removal of office
objections under rule 986. The Court noted that for Section 194 H to apply,
the income being paid out by the airline must be in the nature of commission
or brokerage, and must necessarily be ascertainable in the hands of the
recipient.

2.6 On the facts of the case before it, the Bombay High
Court noted that the airlines had no information about the exact rate at which
the tickets were ultimately sold by the agents, since the agents had been
given discretion to sell the tickets at any rate between the fixed minimum
commercial price and the published price. It was noted by the Court that it
would be impracticable and unreasonable to expect the airline to get feedback
from their numerous agents in respect of each ticket sold. The Court was of
the view that if the airlines had discretion to sell the tickets at a price
lower than the published price, then the permission granted to the agent to
sell it at a lower price could neither amount to commission or brokerage in
the hands of the agent. The Bombay High Court however clarified that any
amount which the agent earned over and above the fixed minimum commercial
price would naturally be income in his hands and would be taxable as such in
his hands.

2.7 The Bombay High Court therefore held that no TDS was
deductible under Section 194H in respect of such discount over the published
fares given by airlines to travel agents.

3. Singapore Airlines’ case :

3.1 The issue again recently came up before the Delhi High Court in the case of Singapore Airlines and 12 other airlines — CIT vs. Singapore Airlines Ltd. (ITA Nos.306/2005 and 123/2006).

3.2 In this case, a survey was conducted on the airlines. This revealed that supplementary commission was being paid to travel agents. The travel agent, after sale, would send the details every two weeks to an organisation Billing Settlement Plan (‘BSP’), which was an organisation approved by the International Air Transport Association, which would prepare an analysis of the billing and send it to each airline. In this analysis, this amount was shown as supplementary commission. The airlines either accounted for this as supplementary commission or incentives/deals. Some travel agents confirmed that such supplementary commission had not been passed on by them to customers. From April 2002, the procedure was changed and tickets were sold at the net price. The Department started proceedings against the airlines for non-deduction of TDS under Section 194H on such supplementary commission.

3.3 The Commissioner (Appeals) upheld the stand of the Department. The Tribunal however allowed the airline’s appeal, holding that the airline received only the net fare from the agent, that any surplus or deficit from such net fare was the profit or loss of the agent, and since such profit or loss was on account of his own efforts and on his own account, did not emanate from services rendered to the airline.

3.4 Before the Delhi High Court, on behalf of the Department it was argued that:

i) the relationship between the assessee-airline and the travel agent was that of a principal and agent and not one of principal to principal.

ii) the supplementary commission retained by the travel agent was not a discount as claimed by the assessee-airline since it was paid for services rendered by the travel agent in the course of buying and selling of tickets;

iii) the submission of the assessee-airline that they had a dual/hybrid relationship with their agent, that is, insofar as the transaction which involved payment of standard commission was that of agency, while that which involved the retention of supplementary commission by the travel agent, that is, price obtained over and above the net fare, was a result of a principal-to-principal relationship ought to be rejected, for the reason that no evidence whatsoever was placed by the assessee-airline to establish that there was such a dual relationship between the parties. The Standard Format Agreement (as approved by lATA), that is, the Passenger Sales Agency (PSA) Agreement executed by the assessee airline was silent as regards any such dual relationship to which the assessee-airline had adverted to;

v) the main provision of Section 194-H included within its ambit payment by cash, cheque, draft or by any other mode. Thus retention of money by the travel agent was covered by the main provisions of Section 194H. It was not the case of the assessee-air line either before the Assessing Officer or the CIT(A) that the travel agent was required to only remit the net fare to the airlines, and this was not even a condition in the PSA Agreement. The net fare was actually arrived at by deducting from the gross fare, tax, standard commission and supplementary commission. While standard commission was fixed by lATA the supplementary commission was variable, as it was dependent on the policies of the airline vis-a-vis their agents. If net fare was the basis for the entire transaction, then there was no necessity of intervention of BSP to carry out a billing analysis, as then the amount payable by the travel agent to the assessee-airline could easily be calculated by taking into account the product of the number of tickets sold and the net fare; and

vi) the amount of supplementary commission which had to be paid on each transaction was embedded in the deal code which was known only to the three concerned parties, that is, the assessee-airline, the travel agent and BSP.Since the assessee-airline was the person responsible for payment of supplementary commission to the travel agent, the tax could have been deducted as and when the billing analysis statement was handed over by the BSP to the airline. It was thus contended that the supplemen-tary commission fell within the ambit of the explanation to Section 194H.

3.5 On behalf of the assessee-airlines, it was argued before the Delhi High Court that:

i) supplementary commission was only a nomenclature which finds mention in the billing analysis statement of BSP.The said supplementary commission denotes a notional figure which is the difference between the published fare less standard IATAcommission (9% or 7%). The net fare is the amount received by the assessee from its travel agents. In other words, the

supplementary commission is not a commission within the meaning of Section 194H;

ii) supplementary commission can only be brought within the ambit of Section 194H, if it fulfils the following criteria as prescribed under the said provision-

a. the sum received must be in the nature of income,

b. such income must denote any payment received or receivable directly or indirectly by the payee from the payer, that is, the assessee, and

c. the recipient should be a person acting on behalf of that another person, and that, the sum received or receivable whether directly or indirectly should be for services rendered in the course of buying and selling of goods, that is, tickets in the present case.

iii) the Department had not been able to produce any evidence to show that the difference between the published fare and the net fare (i.e., the fare the assessee received from the travel agents) was realised by the travel agents. The difference as reduced by standard commission and taxes which is referred to as supplementary commission is only a notional figure and this cannot be termed as a commission within the meaning of Section 194H. What the assessee is entitled to receive is only the net fare. There is no right in the assessee-airline to receive the published fare from the travel agent on sale of tickets;

iv) the notional figure of supplementary commission as appearing in the billing analysis statement of the BSP is neither income nor can it be construed as payment received or receivable, directly or indirectly by the travel agents in its capacity as the agent of the assessee-airline for any services rendered to the assessee-airline. The billing analysis statement of BSP is not a statement of account as contended by the Revenue;

v) since there was no evidence to suggest that the difference between published fare and the net fare was actually received by the travel agent, there was no obligation on the part of the assessee-airline to deduct tax at source on such notional commission which had not been realised;

vi) in these circumstances the provisions of Section 194H were unworkable;

vii) the travel agents had paid tax on the said supplementary commission and hence the Revenue was precluded from raising demands on the assessee-airline.

3.6 Analysing the provisions of Section 194H, the Delhi High Court noted that the provisions of Section 194H would be attracted only if:

i) there is a principal-agent relationship between the assessee-airline and the travel agent;

ii) the payments made by assessee-airline to the travel agent, who is a resident is an income by way of commission;

iii) the income by way of commission should be paid by the assessee-airline to the travel agent for services rendered by the travel agent or for any services in the course of buying or selling of goods;

iv) the income by way of commission may be received or be receivable by the travel agent from the assessee-airline either directly or indirectly; and

v) lastly, the point in time at ‘which obligation to deduct tax at source of the assessee-airline will arise only when credit of such income by way of commission is made to the account of the travel agent or when payment of income by way of commission is made by way of cash, cheque or draft or by any other mode, whichever is earlier.

3.7 Analysing the terms of the PSA agreement and the manner in which the airlines and travel agents functioned, the Delhi High Court concluded that:

i) the travel agent acted on behalf of the airline to establish a legal relationship between an airline and a passenger, and was therefore an agent of the airline, which was his principal;

ii) since it was undisputed that the amount received and retained by the travel agent over and above the net fare would be assessable to tax in his hands as his income, and tax had actually been paid by agents on such income, supplementary commission was ‘income’ within the meaning of Section 194H;

iii) the supplementary commission is not a discount, on account of the fact that the payment retained by the travel agent is inextricably linked to the sale of the traffic document/ air ticket, and the travel agent does not obtain proprietary rights to the traffic documents/air tickets;

iv) there are no two transactions, for one of which commission is paid to the agent, and the second of which is between principal to principal, but just one transaction of sale of tickets on behalf of the airline to the passenger;

v) the amount received by the travel agent over and above the net fare is known to the airline when it receives the billing analysis made by BSP.

The Delhi High Court therefore held that the amount received and retained by the travel agent over and above the net fare was in the nature of commission, liable to deduction of TDS under Section 194H.

4. Observations:
4.1 The conclusions of the Delhi High Court are weighed by one of the facts that the travel agent is an agent of the airline and therefore all and any receipt by him represents commission in his hands, including the difference between the published fare and the net fare.

4.2 The difference between the published fare and the net fare really consists of two components – one component is that of commission as a pre-agreed percentage of the published fare, which is undoubtedly commission covered by the provisions of Section 194H. The other component is the amount not realised by the agent from the client, and therefore not paid to the airline.

4.3 To illustrate, take a situation where the published fare is Rs.50,OOO, the agent’s commission is 7% (Rs.3,500), and the agent sells the ticket to the passenger for Rs.27,500. The agent would collect Rs.27,500 from the passenger and pay Rs.24,OOO to the airline as net fare (ignoring tax), after deducting his commission of Rs.3,500. In this case, the difference between the published fare and the net fare is Rs.26,OOO, consisting of the agent’s commission of Rs.3,500 and the discount passed on to the client of Rs.22,500. This amount of Rs.22,500 is really a discount given by the airline to the passenger through its agent, the travel agent. The travel agent is therefore holding such discount of Rs.22,500 in trust for the passenger, to whom the airline has permitted him to grant such discount.

4.4 With respect to the concerned parties, it was not impressed upon the Delhi High Court that the difference between the published fare and the net fare, in fact was a discount given to the passenger by the airline through the agent and it was the airline alone, ‘which undoubtedly had proprietary rights in the tickets, till such time it was sold to the passengers and the benefit derived by the passenger was a benefit passed on by the airline and not by the agent who received it in trust for the passenger. If the difference is viewed as a discount given to the passenger routed through the agent, as was done by the Bombay High Court, the view taken by the Delhi High Court might have been quite different. As rightly appreciated by the Bombay High Court, the factual position is that the airline has merely granted a permission to the agent to sell the tickets at a lower price, which discount granted through the agent can certainly not be regarded as commission.

4.5 The issue, if any, arises only where in the above example, the travel agent pays to the airline, Rs. 23,000 and not Rs. 24,000 and in the process retains for himself an amount of Rs. 1000. It is this Rs. 1000, whose true nature has to be examined w.r.t. the provisions of s. 194H. This difference so retained may not be a commission within the meaning of Section 194H, unless it is brought within the ambit of Section 194H by proving that the sum received was in the nature of income received or receivable directly or indirectly by the payee from the payer, (that -, IS, the airlines.) and the recipient, (that is, travel agent,) should be a person acting on behalf of that another person, and that, the sum received or reeivable, whether directly or indirectly should be for services rendered in the course of buying and selling of goods, (that is, tickets in the present case). The difference cannot be termed as a commission within the meaning of Section 194H. What the airline is entitled to receive is only the net fare. There is no right in the assessee-airline to receive the published fare from the travel agent on sale of tickets. It cannot be construed as payment received or receivable, directly or indirectly, by the travel agents in its capacity as the agent of the airline for any services rendered to the airline.

4.6 Therefore, the view taken by the Bombay High Court that such discount is not liable to deduction of TDS u/s.194H seems to be the better view of the matter, as compared to the view taken by the Delhi High Court.

Nirav Shah

Monetary limit for filing of appeal by Income-tax Department

Controversies

1. Issue for consideration :

1.1 The Income-tax Department, aggrieved by an order of the
CIT(A), has the right to appeal u/s.253 to the Income-tax Appellate Tribunal and
to the High Court u/s.260A when aggrieved by an order of the Tribunal. An appeal
can also be filed before the Supreme Court with the permission of the Court
against the decision of the High Court. Every year a large number of appeals are
filed by the Income-tax Department, some of which are filed in a routine manner.
Prosecuting these appeals, filed as a matter of course, results in a huge annual
expenditure, at times exceeding the benefit derived from such prosecution.

1.2 Realising the leakage of substantial revenue and with the
intent to avoid litigation, the Government of India, in all its Revenue
Departments, has evolved a policy of refraining from filing an appeal before the
higher authorities, where the monetary effect of the contentious issues causing
grievance, in terms of tax, is less than the acceptable limit. This benevolent
policy of the Government prevents the Courts from being flooded with the cases.

1.3 In pursuance of this policy, the Central Board of Direct
Taxes issues instructions to the Income-tax authorities, directing them to avoid
filing of appeals, where the tax effect of an issue causing a grievance is less
than the monetary limit prescribed under such instructions. Presently,
Instruction No. 2 of 2005, dated October 24,2005, advises the authorities to
refrain from filing appeal before the Tribunal, w.e.f. 31-10-2005, in cases
where the tax effect of the disputed issues is Rs.2,00,000 or less and before
the High Court where such tax effect is Rs.4,00,000 or less and before the
Supreme Court where such tax effect is Rs.10,00,000 or less.

1.4 The said Circular of 2005 is issued in substitution of
the Instruction No. 1979, dated 27-3-2000 which provided that no appeal be
filed, by the Income-tax Dept. before the Tribunal in cases where the tax effect
of the disputed issues is Rs.1,00,000 or less and before the High Court where
such tax effect is Rs.2,00,000 or less and before the Supreme Court where such
tax effect is Rs.5,00,000 or less. The said Circular of 2000 was in substitution
of the Instruction No. 1903, dated 28-10-1992, wherein monetary limits of
Rs.25,000 before the Tribunal, Rs.50,000 for filing reference to the High Court
and Rs.1,50,000 for filing appeal to the Supreme Court were laid down. The said
instruction was in substitution of Instruction No. 1777, dated 4-11-1987.

1.5 It is common to come across cases where the monetary
limit, prescribed by the CBDT prevailing at the time of filing an appeal, has
undergone an upward revision before the time of the hearing of such appeal. In
such cases, the issue that often arises is about the applicability of the
upwardly revised limits, relying upon which the defending assessees contend that
the appeal by the Income-tax Department is not maintainable. The issue was
believed to be settled in favour of the taxpayers by a decision of the Bombay
High Court till recently when the validity of the said decision, in the context
of Instruction of 2005, has been doubted by another Bench of the same Court.

2. Pithwa Engg. Works’ case :

2.1 The issue first came up for consideration in the case of
CIT v. Pithwa Engineering Works, 276 ITR 519 (Bom). The Court examined
whether in deciding the maintainability of an appeal by the Income-tax
Department, the monetary limit of the tax effect, upwardly revised and
prevailing at the time of adjudicating an appeal, should be applied in
preference to the limit prevailing a the time of filing an appeal. In the said
case, at the time of filing the appeal before the High Court, the Instruction
then prevailing, provided for a monetary limit of Rs.50,000. However at the
time, when the appeal came up for hearing , this limit was revised to
Rs.2,00,000 vide Circular dated 27-3-2000.

2.2 The Court took note of its own decision in the case of
CIT v. Camco Colour Co., 254 ITR 565, where-in it was held that the
instructions issued by the Central Board of Direct Taxes, New Delhi, dated March
27,2000 were binding on the Income-tax Department. Under the said Instruction,
the monetary limit, for filing a reference to the High Court, earlier fixed at
Rs.50,000 was revised and fresh instructions were issued to file references only
in cases where the tax effect exceeded Rs.2,00,000.

2.3 The Court in the case before them observed that the said
instructions dated March 27, 2000 reflected the policy decision taken by the
Board, not to contest the orders where the tax effect was less than the amount
prescribed in the above Circular with a view to reduce litigation before the
High Courts and the Supreme Court. The Court did not find any force in the
contention of the Revenue that the said Circular was not applicable to the old
referred cases as such a contention was not taken to a logical end.

2.4 The Bombay High Court negatived the submission of the
Revenue that so far as new cases were concerned, the said Circular issued by the
Board was binding on them and in compliance with the said instructions, they did
not file references if the tax effect was less than Rs.2 lakh, however, the same
approach was not to be adopted with respect to the old referred cases where the
tax effect was less than Rs.2 lakh. The Court did not find any logic behind such
an approach. The Court held that the Circular of 2000 issued by the Board was
binding on the Revenue.

2.5 The Court further proceeded to observe that the Court
could very well take judicial notice of the fact that by passage of time money
value had gone down, the cost of litigation expenses had gone up; the assesses
on the file of the Department have increased; consequently the burden on the
Department had also increased to a tremendous extent; the corridors of the
superior Courts were choked with huge pendency of cases. The Court noted that in
the aforesaid background, the Board had rightly taken a decision not to file
references if the tax effect was less than Rs.2 lakh and the same policy needed
to be adopted by the Department even for the old matters.

2.6 Finally the Court held that the Board’s Circular dated
March 27, 2000 was very much applicable even to the old references which were
still undecided and the Income-tax Department was not justified in proceeding
with the old references, wherein the tax impact was minimal and further there
was no justification to proceed with decades old references having negligible
tax effect.

3. Chhajer Packaging’s case :

3.1 The issue recently came up for consideration, once again, before the same Bombay High Court in the case of CIT v. Chhajer Packaging and Plastics Pvt. Ltd., 300 ITR 180 (Born). In that case, the appeal was filed by the Income-tax Department prior to 24-10-2005, the date when Circular No.2 of 2005 was issue for an upward revision of the monetary limit from Rs.2,OO,OOO to Rs.4,OO,OOO.

3.2 The assessee company in that case, raised the preliminary objection, by relying upon Instruction/ Circular No.2 of 2005, dated October 242005 to plead that since the limit of appeal u/ s.260A of ‘the Act to be preferred was raised to Rs.4 lakh and as the tax effect in its case did not exceed Rs.4 lakh, the Department ought not to have pursued its appeal.

3.3 The above-stated submission of the company was opposed by the Revenue, by contending that the present appeal was filed by the Department in August, 2004, while instruction was issued only on October 24, 2005, which was prospective in nature and therefore, the appeal by the Income-tax Department did not fall within the ambit of the instruction dated October 24, 2005.

3.4 The assessee company in its turn relined upon – the judgment of the Division Bench of the High Court at Bombay, in CIT v. Pithwa Engg. Works, 276 ITR 519, wherein the Court dealt with a similar Circular dated March 27,2000, wherein financial limit for preferring appeals u/ s.260A of the Act before the High Court, was raised to Rs.2 lakh. Reliance was placed on the following observations in the penultimate paragraph (page 521) ; ” In our view, the Board’s Circular dated March 27, 2000, is very much applicable even to the old references which are still undecided” to claim that the Circular was applicable to the appeals which were still pending.

3.5 The Bombay High Court at the outset observed that the views of the Court in Pithwa Engineering’s case pertained to Circular dated March 27, 2000. Thereafter the Court referred to Instruction No. 2/2005, dated October 24, 2005, paragraph 2 “In partial modification of the above instruction, it has now been decided by the Board that appeals will henceforth be filed only in cases where the tax effect exceeds the revised monetary limits given hereunder”.

3.6 Taking into consideration the portion underlined for the purpose of emphasis, the Court held that the Revenue was justified in contending that the Circular was applicable only prospectively and that it made no reference to pending matters. On the basis of the text and considering the applicability of the Circular dated October 24, 2005, the Court declined to follow the view taken by the Court in Pithwa Engineering’ case regarding the earlier circular.

4. Observations:

4.1 The available statistics reveal that the number of appeals filed by the Income-tax Department far outnumber the appeals filed by the taxpayers. This simple statistics convey an important and alarming fact when read with the fact that ninety per cent of these appeals are decided against the Income-tax Department. The emerging conclusion is that most of these appeals are filed as a matter of course, in a routine manner without application of mind as to the viability, efficacy and the cost involved in prosecuting these appeals. The Government today, is the biggest litigant.

4.2 The aforesaid facts when examined in the light of another equally disturbing fact that the Courts today are flooded with the number of cases, which if disposed of at the present pace, will be adjudicated after a scaringly long period.

4.3 It is realisation of these facts and of the enormous costs involved therein that the Government of India evolved a benevolent policy of refraining from pursuing appeals where the tax effect in monetary terms was negligible. It also decided to review the prescribed monetary limits from time to time, keeping in mind the inflation factor. This avowed policy has been religiously followed by the Government by revising the said limits periodically.

4.4 It is this policy background that was kept in mind by the Bombay High Court while deciding in Pithwa Engineering’s case that the revised monetary limits should be applied at the time of adjudicating the appeals. This was done to promote the said avowed policy of avoiding litigation and promote the breathing space in the corridors of Court and was not done to defeat the power of an executive to provide guidelines for administration of the law that it is vested with. This angle of the Court, if appreciated, will enable the Income-tax Department to welcome the said decision with open arms.

4.5 Unfortunately, in Chaajer Packaging’s case the aspects narrated in the above paragraph were not pressed as is apparent from the reading thereof or the Court was not impressed by the same, if they were brought to the attention of the Court. We are sure that had the avowed policy of the Government and the logic of the Court in Pithwa Engineering’s case been brought to the notice of the Court, the decision in Chhajer Packaging’s case could have been different.

4.6 The Bombay High Court even in Carrico Colour Co.’s case, 254 ITR 565 (Born.), much before the Pithwa Engineering’s case had applied the Circular of 2000 in deciding a reference on 26-11-2001 which was filed in 2000 and pertained to A.y. 1990-91.

4.7 With utmost respect to the Court, attention is invited to Paragraph 7 of the said instruction of 2000 which reads as ‘ This instruction will come into effect from 1st April, 2000.’ The said Circular dated 27-3-2000 was specifically made effective from a later date i.e., 1st April, 2000 and was otherwise prospective. In spite of the said Circular being specified to be prospective in its nature, the Court in Pithwa Engineering’s case had held the same to be retrospective. This fact takes away the logic supplied in Chhajer Packaging’s case wherein relying on the use of the term ‘henceforth’ in paragraph 2 of the instructions of 2005, it was held that the said instructions of 2005 were not prospective.

4.8 The Bombay High Court in our opinion should have followed its own decision in Pithwa Engineering’s case as per the law of precedent, as the facts were the same in both the cases. In case of a disagreement, the later case should have been referred to the full Bench. The said decision needs a reconsideration.

Nirav Shah

Whether Reassement u/s.147 is Permissible on a Mere ‘Change of Opinion’

Closements

Introduction :

1.1 S. 147 authorises and permits the Assessing Officer (AO)
to assess or re-assess the income chargeable to tax, if he has reason to believe
that income for relevant years has escaped assessment. This is popularly known
as power of reassessment.

1.2 Provisions of S. 147 have been substituted by the Direct
Tax Laws (Amendment) Act, 1987 with effect from 1-4-1989 (New Provisions).
Primarily, the New Provisions confer jurisdiction to reopen the reassessment,
when the AO, for whatever reason, has ‘reason to believe’ that the income has
escaped assessment.

1.2.1 Under the New Provisions, the above-referred power of
reassessment cannot be exercised after the end of four years from the end of the
relevant assessment year in cases where the original assessment is made
u/s.143(3) or S. 147, unless in such cases, the income chargeable to tax
has escaped assessment for such assessment year by reason of failure of the
assessee to make return u/s.139 or in response to notice u/s.142(1)/148 or by
reason of failure of the assessee to disclose fully and truly all material facts
necessary for such assessment (‘failure to disclose material facts’). In this
write-up we are not concerned with this provision.

1.3 Prior to substitution of the provisions of S. 147 w.e.f.
1-4-1989 as aforesaid (i.e., New Provisions), S. 147 providing for
reassessment was divided into two separate clauses [(a) and (b)], which laid
down the circumstances under which income escaping assessment for the past
assessment years could be assessed or re-assessed (Old Provisions). Under the
Old Provisions, clause (a) empowered the AO to initiate proceedings for
re-assessment in cases where he has ‘reason to believe’ that by reason of the
omission or failure of the assessee to make return u/s.139 or by reason of the
‘failure to disclose the material facts’, the income chargeable to tax has
escaped assessment. Under clause (b) of the Old Provisions, the AO was empowered
to initiate reassessment proceedings if, in consequence of information in his
possession, he has ‘reason to believe’ that income chargeable to tax has escaped
assessment, even if there is no omission or failure on the part of the assessee
as mentioned in clause (a).

1.4 From the comparison of the Old Provisions with the New
Provisions relating to re-assessment, it would appear that to confer
jurisdiction under clause (a) of the Old Provisions, it would appear that two
conditions were required to be satisfied, namely, (i) the AO must have ‘reason
to believe’ that income chargeable to tax has escaped assessment, and (ii) such
escapement has occurred by reason of ‘failure to disclose material facts’, etc.
on the part of the assessee. On the other hand, under the New Provisions, the
existence of only first condition (i.e., ‘reason to believe’) is
sufficient to confer the jurisdiction on the AO to initiate the reassessment
proceedings (except, of course, in cases covered by the circumstances mentioned
in Para 1.2.1 above).

1.5 Various issues are under debate with regard to powers of
the AO to make reassessment under the New Provisions. In large number of cases,
reassessment proceedings are being initiated merely on account of ‘change of
opinion’ on the issues decided at the time of original assessment. In such
cases, the issue has come up before the Courts in the past as to whether, under
the New Provisions, the AO is empowered to initiate reassessment proceedings on
a mere ‘change of opinion’. By and large, the Courts have taken a view that
reassessment proceedings cannot be initiated on a mere ‘change of opinion’.
However, the issue still survives and in practice, such re-assessment
proceedings are being initiated on a mere ‘change of opinion’ by giving one
reason or the other.

1.6 Recently, the issue referred to in Para 1.5 above came up
for consideration before the Apex Court in the case of Kelvinator of India Ltd.
and the same is finally resolved by the Apex Court. Considering the importance
of the issue in day-to-day practice, it is thought fit to consider the said
judgment in this column.

CIT v. Kelvinator of India Ltd., 256 ITR 1
(Del.) — Full Bench :

2.1 In the above case, the issue referred in Para 1.5 above
was referred to the Full Bench of the Delhi High Court. In that case, the facts
were : The assessee had furnished the return of income for the A.Y. 1987-88 on
29-6-1987. The assessee had maintained guest houses at different places on which
it had incurred total expenditure of Rs.3,33,926 consisting of rent
(Rs.1,76,000), depreciation (Rs.66,441) and other expenses (Rs. 91,485). As it
did not claim deduction for these expenses, revised return was filed on
5-10-1989 along with a letter mentioning that out of the above amount of
Rs.3,33,926, the rent and depreciation should be allowed as deduction u/s.30 and
u/s.32 of the Act, relying on the judgment of the Bombay High Court in the case
of Chase Bright Ltd. (177 ITR 124). Accordingly, disallowance of the expenses
u/s.37(4) of the Act was restricted to only Rs.91,485 and the relevant order was
passed on 17-11-1989. Subsequently, notice u/s.148 was issued on 20-4-1990 for
reopening of the assessment u/s.147. Though as per the reasons recorded for
reopening, the assessment was reopened on the alleged ground of various
disallowable claims, but except for the above referred two items of
disallowances, neither any claim was disallowed, nor any addition was made on
completion of reassessment. In support of the reassessment, the AO had relied
upon the order of the CIT(A) for the A.Y. 1986-87, which was passed on 7-7-1990,
although the assessment was reopened on 2-4-1990. In the appeal filed against
the reassessment order, the CIT(A) quashed the reassessment proceedings on the
ground that it was a case of mere ‘change of opinion’ on the part of the AO as
no new fact or material was available with the AO The Appellate Tribunal also
upheld the decision of the CIT(A) and it was held that New Provisions of S. 147
are applicable in this case and it was also a case of mere ‘change of opinion’.

2.2 On the above facts, the Revenue made an application for
referring the following questions to the High Courts (para 5) :

“Whether, the Income-tax Appellate Tribunal was correct in
holding that the proceedings initiated u/s.147 of the said Act were invalid on
the ground that there was a mere ‘change of opinion’ ?”

2.3 The above-referred application was rejected by the
Tribunal and hence, at the instance of the Revenue, a petition was filed
u/s.256(2) before the Delhi High Court for direction to Tribunal for referring
the above-referred question to the High Court.

2.4 Before the High Court, the counsel appearing on behalf of the Revenue, referred to the provisions of S. 34 of the Indian Income-tax Act, 1922 (the 1922 Act) and the Old Provisions as well as the New Provisions of S. 147 of the Income-tax Act, 1961 (the Act). He also pointed out that the proviso to S. 147 under the New Provisions is in pari materia with Clause (a) of S. 147 under the Old Provisions. It was, inter alia, further contended that the ‘change of opinion’ is relevant only for the purpose of Clause (b) of S. 147 under the Old Provisions, the initiation of reassessment proceedings is permissible when it is found that the AO has passed the assessment order without any application of mind and the same can be found out from the order of assessment itself. When the order of the assessment does not contain any discussion on a particular issue, then the same may be held to have been rendered without any application of mind. It was further contended that from the reasons recorded by the AO, it is apparent that reliance has been placed upon the tax audit report which would have come within the purview of the expression ‘information’ as contemplated in 147 and hence, the re-assessment cannot be said to be illegal or without jurisdiction. For this purpose, reliance was placed on various judgments of the Courts including the judgments of the Gujarat High Court in the case of Praful Chunilal Patel (236 ITR 832) and a Delhi High Court case of Bawa Abhai Singh (253 ITR 83). It was also contended that Circular No. 549, dated 31-10-1989 issued by the CBDT (Circular No. 549) cannot be relied upon for the purpose of construction of New Provisions inasmuch as the Circular cannot override the statutory provisions.

2.5 On the other hand, on behalf of the assessee, it was, inter alia, contended that the expression ‘reason to believe’ contained in S. 147 denotes that the belief must be based on the change of fact or subsequent information or new law. Income escaping assessment must be founded upon or in consequence of any information which must come into the possession of the AO after completion of the original assessment. It was also pointed out that the said Circular No. 549 clearly shows that S. 147 was amended only to allay fear of all concerned that prior thereto an arbitrary power was conferred upon the AO and the CBDT, who has the authority to interpret the law, has issued the said Circular No. 549, which should govern the case. Reliance was also placed on various judgments of the Courts in support of contentions raised.

2.6 After considering the contentions raised on behalf of both the parties, the Court proceeded to consider the issue and for that purpose noted the provisions regarding reassessment under 1922 Act as well as the Old Provision and the New Provision under the Act. The Court also noted the said Circular No. 549. The Court then also referred to the various judgments of the Courts rendered under 1922 Act as well as the Old Provisions and the New Provisions of the Act dealing with the issue, wherein the view was taken that reassessment proceedings cannot be initiated on a mere ‘change of opinion’. Referring to the New Provisions, the Court noted the following observations (head notes) of the Delhi High Court (234 ITR 170) in the case of Jindal Photo Films Ltd. (page 13):

“The power to reopen an assessment was conferred by the Legislature not with the intention to enable the Income-tax Officer to reopen the final decision made against the Revenue in respect of questions that directly arose for decision in earlier proceedings. If that were not the legal position, it would result in placing an unrestricted power of review in the hands of the assessing authorities depending on their changing moods.”

2.7 After considering the above, the Court stated that although the referring Bench had prima facie agreed with the decision of this Court in the case of Jindal Photo Films Ltd. (supra), but doubt was sought to be raised by the Revenue in view of the decision of the Gujarat High Court in the case of Praful Chunilal Patel (supra). Accordingly, the Court considered the said judgment of the Gujarat High Court and noted that in that case it was held that the word ‘assessment’ would mean the ascertainment of the amount of taxable income and the tax payable thereon. In other words, where there is no ascertainment of amount of taxable income and the tax payable thereon, it can never be said that such income was assessed. It was further held that merely because during the assessment proceedings the relevant material was on record, it cannot be inferred that the AO must necessarily have deliberated over it and taken in to account while ascertaining the taxable income or that he had formed an opinion in respect thereof. If looking back, it appears to the AO (albeit, within four years from the end of the relevant assessment year) that particular item even though reflected on the record was not subjected to assessment and was left out while working out the taxable income earlier, that would enable him to initiate the proceedings for reassessment. After referring to this view expressed by the Gujarat High Court in that case, the Court disagreed with the same and stated as under (page 15):

“We are, with respect, unable to subscribe to the aforementioned view. If the contention of the Revenue is accepted the same, in our opinion, would confer an arbitrary power upon the Assessing Officer. The Assessing Officer who had passed the order of assessment or even his successor officer only on the slightest pre-text or otherwise would be entitled to reopen the proceeding. Assessment proceedings may be furthermore reopened more than once. It is now trite that where two interpretations are possible, that which fulfils the purpose and object of the Act should be preferred.”

2.8 The Court then also considered the judgment of the Delhi High Court in the case of Bawa Abhai Singh (supra) on which reliance was placed by the Revenue to contend that reassessment proceedings can be initiated on a mere ‘change of opinion’. The Court then noted that in that case it was held that the Old Provisions and the New Provisions are contextually different. Under the New Provisions, the only condition for initiating the reassessment proceeding is that the AO should have ‘reason to believe’ that income has escaped assessment, which belief can be reached in any manner and is not qualified by any pre-condition of faith and true disclosure of material fact by the assessee as contemplated under the Old Provisions in clause of S. 147. Accordingly, the power to re-open the assessment under the New Provisions is much wider and can be exercised even after the assessee has disclosed fully and truly all material facts. After noting this part of the said judgment, the Court stated that it is evident that this judgment cannot be considered as an authority for the proposition that mere ‘change of opinion’ would also confer jurisdiction upon the AO to initiate reassessment proceedings as was contended on behalf of the Revenue.

2.9 Dealing with the meaning of the expression ‘reason to believe’, the Court noted the following view expressed by the Delhi High Court in the earlier referred judgment of Bawa Abhai Singh (supra), on which reliance was placed on behalf of the Revenue (page 16):

“The crucial expression is ‘reason to believe’. The expression predicates that the Assessing Officer must hold a belief?.?.?.?. by the existence of reasons for holding such a belief. In other words, it contemplates existence of reasons on which the belief is founded and not merely a belief in the existence of reasons inducing the belief. Such a belief may not be based merely on reasons but it must be founded on information. As was observed in Ganga Saran and Sons P. Ltd. v. ITO, (1981) 130 ITR 1 (SC), the expression ‘reason to believe’ is stronger than the expression ‘is satisfied’. The belief entertained by the Assessing Officer should not be irrational and arbitrary. To put it differently, it must be reasonable and must be based on reasons which are material. In S. Narayanappa v. CIT, (1967) 63 ITR 219, it was noted by the Apex Court that the expression ‘reason to believe’ in S. 147 does not mean purely a subjective satisfaction on the part of the Assessing Officer, the belief must be held in good faith; it cannot be merely a pretence. It is open to the Court to examine whether the reasons for the belief have a rational nexus or a relevant bearing to the information of the belief and are not extraneous or irrelevant for the purpose of the Section. To that limited extent, the action of the Assessing Officer in initiating proceedings u/s. 147 can be challenged in a Court of law.”

2.10 To decide the issue, the Court then further stated that it is a well-settled principle of interpretation of statute that the entire statute should be read as a whole and the same has to be considered thereafter chapter by chapter and then section by section and ultimately word by word. It is not in dispute that the AO does not have any jurisdiction to review his own order. His jurisdiction is confined to only rectification of apparent mistakes u/s.154 and the said powers cannot be exercised where the issues are debatable. According to the Court, what cannot be done directly, cannot be done indirectly by taking recourse to provisions relating to reassessment. For this, the Court observed as under (page 15):

“It is a well-settled principle of law that what cannot be done directly cannot be done indirectly. If the Income-tax Officer does not possess the power of review, he cannot be permitted to achieve the said object by taking recourse to initiating a proceeding of reassessment or by way of rectification of mistake.

2.11 The Court then considered the contention raised on behalf of the Revenue that the said Circular No. 549 cannot be considered, as the Circular cannot override the statutory provisions. In this context, the Court reiterated the settled position with regard to the binding effect of the Circular issued by the CBDT for which reference was made to the judgments of Apex Court in the cases of UCO Bank (237 ITR 889) and Anjum M. H. Ghasswalla (252 ITR 1). The Court, then, felt that if the AO is permitted to reopen the completed assessment on a mere ‘change of opinion’, then the powers of the AO become arbitrary. In this context, the Court observed as under (page 19):

“Another aspect of the matter also cannot be lost sight of. A statute conferring an arbitrary power may be held to be ultra vires Article 14 of the Constitution of India. If two interpretations are possible, the interpretation which upholds constitutionality, it is trite, should be favoured.

In the event it is held that by reason of S. 147 if the Income-tax Officer exercises his jurisdiction for initiating a proceeding for reassessment only upon a mere change of opinion, the same may be held to be unconstitutional. We are therefore of the opinion that S. 147 of the Act does not postulate conferment of power upon the Assessing Officer to initiate reassessment proceeding upon his mere change of opinion.”

2.12 While taking a view that on a mere ‘change of opinion’ reassessment proceedings cannot be initiated, even if the detailed reasons have not been recorded in the original assessment order for accepting the claim of the assessee, finally, the Court stated as under (pages 19/20):

“We also cannot accept the submission of Mr. Jolly to the effect that only because in the assessment order, detailed reasons have not been recorded an analysis of the materials on the record by itself may justify the Assessing Officer to initiate a proceeding u/s.147 of the Act. The said submission is fallacious. An order of assessment can be passed either in terms of Ss.(1) of S. 143 or Ss.(3) of S. 143. When a regular order of assessment is passed in terms of the said Ss.(3) of S. 143, a presumption can be raised that such an order has been passed on application of mind. It is well known that a presumption can also be raised to the effect that in terms of clause (e) of S. 114 of the Indian Evidence Act judicial and official acts have been regularly performed. If it be held that an order which has been passed purport-edly without application of mind would itself confer jurisdiction upon the Assessing Officer to reopen the proceeding without anything further, the same would amount to giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong.”

CIT v. Kelvinator of India Ltd., 320 ITR 561 (SC):

3.1 The above-referred judgment of the Full Bench of the Delhi High Court came up for consideration before the Apex Court to decide the issue referred to in para 1.5 above.

For this purpose, the Court noted the Old Provisions as well as the New Provisions of S. 147. The Court then stated that on going through the changes made under the New Provisions, we find that for the purpose of reopening, two conditions were required to be fulfilled under the Old Provisions, but under the New Provisions they are given go by and only one condition has remained, namely, that once the AO has reason to believe that income has escaped assessment, that confers the jurisdiction for reopening. Therefore, under the New Provisions, power to reopen is much wider. However, one needs to give schematic interpretation to the words, ‘reason to believe’, failing which S. 147 would give arbitrary powers to AO to reopen assessment on the basis of a mere ‘change of opinion’. One must also keep in mind the conceptual difference between the power of review and power of reassessment. The AO has no power to power to review; he has the power to reopen. Having made these observations, the Court then held as under (pages 564/565):

“But reassessment has to be based on fulfilment of certain pre-conditions and if the concept of ‘change of opinion’ is removed, as contended on behalf of the Department, then, in the garb of reopening the assessment, review would take place. One must treat the concept of ‘change of opinion’ as an in-built test to check abuse of power by the Assessing Officer. Hence, after 1st April, 1989, the Assessing Officer has power to reopen, provided there is ‘tangible material’ to come to the conclusion that there is escapement of income from assessment. Reasons must have a live link with the formation of the belief. Our view gets support from the changes made to S. 147 of the Act, as quoted hereinabove. Under the Direct Tax Laws (Amendment) Act, 1987, the Parliament not only deleted the words ‘reason to believe’, but also inserted the word ‘opinion’ in S. 147 of the Act. However, on receipt of representations from the companies against omission of the word ‘reason to believe’, the Parliament reintroduced the said expression and deleted the word ‘opinion’ on the ground that it would vest arbitrary powers in the Assessing Officer.”

3.2 In support of the aforesaid view, the Court also relied on the said Circular No. 549 and reproduced the following portion therefrom (page 565):

“7.2 Amendment made by the Amending Act, 1989, to reintroduce the expression ‘reason to believe’ in S. 147. — A number of representations were received against the omission of the words ‘reason to believe’ from S. 147 and their substitution by the ‘opinion’ of the Assessing Officer. It was pointed out that the meaning of the expression, ‘reason to believe’ had been explained in a number of Court rulings in the past and was well settled and its omission from S. 147 would give arbitrary powers to the Assessing Officer to reopen past assessments on mere change of opinion. To allay these fears, the Amending Act, 1989, has again amended S. 147 to reintroduce the expression ‘has reason to believe’ in place of the words ‘for reasons to be recorded by him in writing, is of the opinion’. Other provisions of the new S. 147, however, remain the same.”

Conclusion:

4.1 From the above judgment of the Apex Court, it is now clear that even under the New Provisions, reassessment proceedings cannot be initiated on a mere ‘change of opinion’. One of the major reasons for taking such a view also appears to be the fact that if the AO is permitted to reopen the assessment on a mere ‘change of opinion’, S. 147 would give arbitrary powers to the AO to reopen reassessment. Therefore, the concept of ‘change of opinion’ is treated as inbuilt test to check the abuse of power by the AO.

4.2 If the AO is permitted to reopen concluded assessment on a mere ‘change of opinion’, his power may become arbitrary and statute confirring arbitrary power may be held unconstitutional as held by the Full Bench of the Delhi High Court in the above case.

4.3 From the above judgment read with the Full Bench Judgment of the Delhi High Court, it seems that the completed assessment can be reopened only when there is a tangible material available with the AO to form a belief that taxable income has escaped assessment. The belief entertained by the AO should not be irrational and arbitrary. It must be reasonable and must be based on reasons which are material.

4.4 We may also state that if the return of income is processed u/s.143(1) without making any assessment u/s.143(3)/147, then such determination of income does not amount to ‘assessment’ [Ref. Rajesh Jhaveri Stock Broker P. Ltd., 291 ITR 500 – SC]. Therefore, in such cases, it seems that the above-referred judgment of the Apex Court may not be of any use to contest the assessment proceedings initiated u/s.147.

Nirav Shah

Recovery of debts — Tribunal has no power to control physical movement of defendant borrower — It cannot impound passport — Recovery of Debts due to Banks and Financial Institution Acts, 1993 S. 19, S. 22.

New Page 1

[Prafulchandra V. Patel & Ors. v. State Bank of India &
Ors., AIR 2010 Gujarat 46]

The respondent-bank had filed a petition against the
petitioners for recovery of amount of Rs.37 crores with accrued interest.
Simultaneously an application for interim injunction by the bank to restrain the
petitioners, to transfer of the property and the petitioners from leaving India
without prior permission. The Tribunal granted interim injunction in respect to
properties, however, it did not grant any injunction for restraining the
petitioners from leaving India. Later in another application the Tribunal
restrained the petitioner from leaving India without prior permission of the
Tribunal. The said order was challenged before the High Court on the limited
issue of restraining the petitioner from leaving India.

The Court held that the Debt Recovery Tribunal has no power
to control the physical movement of the defendant-borrowers in absolute, merely
because suit for recovery or the proceedings for recovery of amount, if filed,
in capacity as the mortgagee by the plaintiff bank.

The Tribunal under the RDB Act has power to command and
control the properties of the defendants, may be in its possession or in
possession of third party, and the powers are to be used for grant of injunction
for such purpose. It is only when the Tribunal satisfactorily finds that the
defendant is obstructing the Tribunal or its officers from having command and
control over properties of the defendant, in possession of the defendant or in
possession of third party, the powers may be exercised by the Tribunal to
control and restrict physical movement of the defendant, but not otherwise. But
the Tribunal has no power in absolute to prohibit the physical movement of the
defendants beyond its territorial jurisdiction or to prohibit the defendants
from leaving the country. Thus, the Tribunal has no power to direct impounding
of the passport.

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Nirav Shah

Precedents — One Bench cannot differ from the view of another Co-ordinate Bench — In case of difference in views, matter must be referred to a Larger Bench.

New Page 1

[Mercedes Benz India Pvt. Ltd. v. UOI, 2010 (252) ELT
168 (Bom.)]

One Bench of the Tribunal decided an appeal in favour of the assessee. However, another Bench refused to follow that decision
even though the facts were the same, on the ground that the earlier decision did
not address the grievance of the Revenue and did not consider all the facts and
did not lay down a clear ratio. The assessee filed a writ petition complaining
of breach of propriety on the part of the Tribunal by not referring the issue to
a
Larger Bench.

The Bombay High Court observed that in a multi-Judge Court,
the Judges are bound by precedents and procedure. They could use their
discretion only when there is no declared principle to be found, no rule and no
authority. The judicial decorum and legal propriety demand that where a learned
single Judge or a Division Bench does not agree with the decision of a Bench of
co-ordinate jurisdiction, the matter should be referred to a Larger Bench. It is
a subversion of judicial process not to follow this procedure. In the system of
judicial review which is a part of the Constitutional scheme, it is held to be
the duty of the Judges of the Courts and Members of the Tribunals to make the
law more predictable. The question of law directly arising in the case should
not be dealt with apologetic approaches. The law must be made more effective as
a guide to behaviour. It must be determined with reasons which carry convictions
within the Courts, profession and public. Otherwise, the lawyers would be in a
predicament and would not know how to advise their clients. Subordinate Courts
would find themselves in an embarrassing position to choose between the
conflicting opinions. The general public would be in dilemma to obey or not to
obey such law and it, ultimately, falls into disrepute.

The Court further held that the view taken by the Tribunal
was not the correct approach. If the Tribunal wanted to differ to the earlier
view taken by the Tribunal in an identical set of facts, judicial discipline
required reference to the Larger Bench. One Co-ordinate Bench finding fault with another Co-ordinate Bench is not a healthy way of dealing with the matters.

Note : In UOI v. Paras Laminates Pvt. Ltd., (1990) 186 ITR
722 (SC) it was held that an order which did not follow a Co-ordinate Bench
decision was ‘per incuriam’ i.e., not a binding judicial precedent.

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Nirav Shah

Torts : Person losing his right hand due to electrocution — Electricity Board liable to compensate.

New Page 1

TORTS : Person losing his right hand due to
electrocution — Electricity Board liable to compensate.

Petitioner got electrocuted on account of a live wire which
snapped due to strong wind and fell on roof of petitioner’s house, which had
C1 sheet roofing. It was held that Electricity Board ought not to have carried
electrical wire over a dwelling house. A person undertaking activity involving
generation or transmission of electricity which is inherently dangerous to
human should take extra care and precaution to avoid harm. However, the
Electricity Board authorities have not shown that they have taken all
necessary care to avoid harm. The petitioner being sole bread-earner of his
family and has lost his right hand being amputed, is entitled to be
compensated for his sufferings and loss of earning and earning capacity.
Compensation of Rs.3,00,000 awarded including medical expenses.

[Md. Sahajuddin vs. ASEB & Ors., AIR 2009 (NOC) 1072 (Gau.)].

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Nirav Shah

Appellate Tribunal — Passing of order — Reasonable time — Order passed after six months — Order set aside on ground of delay — S. 129B of Customs Act, 1962.

New Page 1

[Shantilal Jain v. UOI, 2010 (252) ELT 326 (Bom.)]

In this case the impugned order was passed by the Customs,
Excise and Service Tax Appellate Tribunal practically after a period of six
months from the date of hearing. The Bombay High Court set aside the order
without examining merits or demerits thereof and the appeal was restored to the
file of the
Tribunal for de novo hearing and decision afresh. The Court relied on the case
of Dewang Rasiklal Vora v. Union of India, 2003 (158) ELT 30 (Bom.); wherein it
was held that the judgment passed after considerable gap of time from the date
of hearing was
liable to be set aside, observing that justice should not only be done, but must
manifestly appear to
be done.

The Court also showed displeasure on the conduct of the
advocates signing the minutes of the order on behalf of the Revenue, which was
found to be not as per consensus between the advocates. The Court observed that
it was the obligation on the part of the advocate for the Revenue to protect the
interest of the Revenue and to be more diligent.

See Shivsagar Veg Restaurant v. CIT, (2009) 317 ITR 433 (Bom.)

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Nirav Shah

Translation of document : Filing of translated copy of document in Court is not additional evidence — Only requirement is that counsel should certify that translation is correct : Civil Procedure Code : O.13, R.4, General Rules (Civil) 1986, Rule 37.

New Page 1

Translation of document : Filing of translated copy of
document in Court is not additional evidence — Only requirement is that
counsel should certify that translation is correct : Civil Procedure Code :
O.13, R.4, General Rules (Civil) 1986, Rule 37.

The plaintiff filed a suit for permanent injunction. In the
suit the plaintiff relied upon a registered sale deed dated 26.7.1926,
executed by one Bhanwaria and based his title in the property upon the said
sale deed. The said registered sale deed was in Urdu script and language.

After filing of the appeal against the dismissal of suit by
the learned trial Court, the plaintiff-appellant submitted an application with
prayer that the plaintiff had during the trial filed a copy of the registered
sale deed which was written in Urdu script and with a view to facilitate the
Court to peruse and go through the contents of the said document, the
appellant is filing a correct translation of the same in Devanagari script
having translated the document from Urdu script to Devanagari script (in
Hindi).

The appellant further submitted that so far as the
application was concerned, it was not one under O. 41, R. 27, C.P.C. of
leading any additional evidence but in fact the appellant was only submitting
the translated version of the document, the registered sale deed of the year
1926 which has already been filed before the learned trial Court and admitted
in evidence of the plaintiff and since the parties were not conversant with
Urdu language or the script, the appellant could not state before the Court as
to what were the contents of the said documents. When the suit was dismissed
by the learned Trial Court the appellant with a view to overcome the aforesaid
difficulty, produced before the Court the translated version which cannot be
said to be by means of an additional evidence strictly in accordance with the
provisions of O. 41, R. 27, C.P.C. It was evident from the document that the
counsel had certified and put an endorsement.

The Hon’ble Court held that the provisions of O. 14, R.27,
C.P.C. were not strictly applicable as it was not a case where any additional
evidence was sought to be produced by the appellant which had not been filed
before the learned trial Court and was being sought to be filed for the first
time in the appeal. By the application, all that the petitioner sought to do
was to file a translated copy of sale deed which is in Urdu language by filing
a translation in Devanagari script in Hindi for being appreciated by the Court
and it is for this purpose that the application was filed by the plaintiff.

The Rule 37 of the General Rules (Civil), 1986 requires (1)
that a correct translation of the document which is not written in Hindi or
English to be accompanied by a translation of the same into Hindi written in
Devanagari script; (2) that the translated document must bear a certificate of
the party’s counsel to the effect that it is a correct translation; and (3)
that if the party filing the same is not represented by a counsel, the Court
shall have the same certified by any person appointed by it at the cost of the
party seeking to produce the document.

The document which had been filed before the Appellate
Court showed that it was signed by the advocate who had endorsed the same to
be the true translated copy from Urdu script into Devanagari script. It was
not the case that the aforesaid document was not a correct translation, but
the application had been rejected by the learned Appellate Court on the ground
that it does not bear endorsement and the name of the person who has
translated the said document.

A look at Rule 37 of the General Rules (Civil), 1986, goes
to show that the requirement is that “the translation shall bear a certificate
of the party’s counsel to the effect that the translation is correct.” The
Rule does not require an endorsement by the counsel that he has translated the
document into Hindi but only requires a certificate ‘the translation is
correct’.

In view of the matter, the learned Appellate Court which
did not advert to the provisions of Rule 37 of the General Rules (Civil),
1986, while passing the order committed an error of jurisdiction.

[Prahlad Singh vs. Suraj Mal & Ors., AIR 2009
Rajasthan 53].

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Nirav Shah

Public document : Certified copy of power of attorney which is registered document on file of Sub-Registrar is a public document : Evidence Act Sec. 74(2).

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Public document : Certified copy of power of attorney which
is registered document on file of Sub-Registrar is a public
document : Evidence Act Sec. 74(2).

The suit had been instituted by the petitioner on the
factual premise that as per the power of attorney executed by the respondent
on 29.01.1993, he was permitted to develop the land belonging to the
respondent, having an extent of 1.50 acres and a certified copy of the said
power of attorney was produced along with the plaint. However, the suit was
contested by the respondent on the ground that only an extent of 50% of
property were given as per the said power of attorney and the petitioner with
the connivance of the officials of the Registration Department fraudulently
changed the extent as 1.50 acres instead of the original extent of 50%.
Subsequently, during the course of trial, the petitioner attempted to mark the
certified copy of the power of attorney as a document on his side. The same
was objected to by the respondent mainly on the ground that loss of original
has not been properly accounted in terms of Section 65 of the Indian Evidence
Act.

The document produced by the petitioner was rejected by the
learned District Munsif on the ground that certified copy of power of attorney
cannot be admitted in evidence. The petitioner had contended before the Trial
Court that the original was lost and the same was also mentioned in the plaint
as well as in the proof affidavit and as such, he was entitled to lead
secondary evidence.

The Hon’ble Court observed that the document produced by
the petitioner as document No.1 is found to be a certified copy of the power
of attorney registered as document No.13/1993 on the file of Sub-Registrar.
Admittedly, the document was a registered document and what was produced by
the petitioner was only a certified copy of the said document. Section 74 of
the Indian Evidence Act, 1872 indicates as to what are all the documents which
could be termed as public documents. As per Sub-Section 2 of Section 74,
public records kept (in any State) of private documents are public documents.
Section 76 mandates that every public officer having the custody of the public
document, which any person has a right to inspect, shall give that person on
demand a copy of it on payment of the legal fees therefor, together with a
certificate written at the foot of such copy that it is a true copy of such
document or part thereof, as the case may be, and such certificate shall be
dated and subscribed by such officer with his name and his official title, and
shall be sealed, whenever such officer is authorised by law to make use of
seal; and such copies so certified shall be called certified copies.

As per Section 77, such certified copies may be produced in
proof of the contents of the public documents or parts of the public documents
of which they purport to be copies. Section 79 of the Indian Evidence Act
gives a statutory presumption with respect to the genuineness of certified
copies.

Therefore, it was evident that the certified copy of the
power of attorney produced by the petitioner is a public document within the
meaning of Section 74(2) of the Indian Evidence Act and the same is admissible
in evidence as provided under Section 76 of the Act.

The alleged alteration in the original deed was a matter
for evidence. It would be open to the respondent to summon the office copy of
the document sought to be marked and to take steps to send the same for expert
opinion. It is also possible for the respondent to take steps to prove her
contention that there were alterations made in the document subsequent to the
registration.

[P. K. Pandian vs. Komala, AIR 2009 Madras 51].

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Nirav Shah

Additional evidence : Permission to bring additional document can be granted in exercise of discretion of Court to achieve ends of justice

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10. Additional evidence : Permission to bring additional
document can be granted in exercise of discretion of Court to achieve ends of
justice.

The plaintiffs had challenged an order passed by the
learned Single Judge, dated 15th January, 2008 allowing the Chamber Summons
which is taken out by the defendants seeking liberty to lead evidence and to
place on record all documents referred to in the affidavit of documents which
was filed by the defendants. Grievance of the plaintiffs is that after they
had led their evidence, the defendants had specifically informed the Court
that they did not wish to lead any evidence. It is the contention of the
plaintiffs that after having taken a stand not to lead evidence, it was not
open for the defendants to subsequently file application seeking permission of
the Court to lead evidence.

The power to permit the party to lead additional evidence
had been given to the Appellate Court under Order XLI Rule 27. It is settled
position in law that the purpose of procedural law is not to frustrate the
rights of the parties, but the law is primarily to achieve the ends of justice
and fully and finally decide the controversy between the parties.

While interpreting the provisions of the Code, care should
be taken that substantial justice is not sacrificed for hypertechnical pleas
based on strict adherence to procedural provision. In this context, reference
be made to the Apex Court in the case of Ghanshyam Dass and Ors vs.
Dominion of India and Ors., reported in (1984) 3 SCC 46. Thus the Appeal
Court is entitled to allow the party to lead additional evidence.

In view of provisions of Order VIII Rule 1 & Order XLI Rule
27, the learned Single Judge has exercised a discretion vested in him and has
permitted the defendants to bring on record any such documents. In the present
case, it has to be noted that affidavit of documents was filed by the
defendants. The documents could not be traced and, subsequently, the
defendants were in a position to procure the said documents and, after an
application for amendment which was filed by the plaintiff was allowed and
permission was granted to the parties to file additional written statement,
the application for production of documents was made and the learned Single
Judge was pleased to allow the said application. Therefore, the order passed
by the learned Single Judge was upheld.

[Smt. Shantibai K. Vardhan & Ors. vs. Ms. Meera G. Patel
& Anr. AIR 2009 (NOC) 904 (Bom).]

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Nirav Shah

Family arrangement : If Family arrange-ment is for relinquishment of any immovable property it requires registra-tion — Registration Act, Sec. 17.

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Family arrangement : If Family arrange-ment is for
relinquishment of any immovable property it requires registra-tion — Registration
Act, Sec. 17.

In a suit for partition an alleged oral family arrangement
was relied in the written statement of the defendants. It was not known as to
when and on which date such oral arrangement took place and in whose presence.
There was no clinching evidence in that regard. The Hon’ble Court observed
that the law was clear on the point that family arrangement could be oral, but
if it was to be recorded it should be by way of memorandum so as to dispel
hazy notion about such oral arrangement and it should not be in evidence of
it. If it is in evidence of relinquishment of any immovable property it would
require registration within the meaning of Section 17 of the Registration Act.

[D. V. Narayana Sah & Ors. vs. A. G. Nagammal & Ors.
AIR 2009 (NOC) 1061 (MAD.)].

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Nirav Shah

Share broker and Stock Exchange render ‘services’ to the investors and investor would be ‘consumer’ : Consumer Protection Act S. 2(1)(d) and S. (2)(1)(o).

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15 Share broker and Stock Exchange render
‘services’ to the investors and investor would be ‘consumer’ : Consumer
Protection Act S. 2(1)(d) and S. (2)(1)(o).

The respondent share broker who was a member of the DSE
committed default in making payment or delivery of shares for which demand had
to be made by the complainant investor.

U/s.19 of Securities Contracts (Regulation) Act, 1956, no
person can organise or assist in organising or be a member of any stock exchange
other than a recognised stock exchange for the purpose of assisting in, entering
into or performing any contracts in securities. In view of aforesaid bar on
doing business as a share broker, a person has to become a member of a
recognised stock exchange. Without
becoming member of a stock exchange, share brokers are not permitted to have any
transaction in purchase and sale of shares. Therefore, the stock exchange is
apparently a service provider for purchase and sale of shares and not only does
the broker render ‘service’ in the purchase and sale of listed securities but
the stock exchange is also required to render service to the investors.

Further, the Delhi Stock exchange (DSE) is also a service
provider as stated in the memorandum and articles of Association because it
controls the mode, manner, time and place of performance of contract between the
broker member and the investors. DSE is required to establish and had
established Delhi Stock Exchange Customer Protection Fund. Every Member of the
DSE is required to become a member of the fund and contribute annually to the
Fund. If a member of DSE is declared as defaulter, the trustee of the fund step
into the shoes a defaulter member. This fund is established to protect and
safeguard interests of investors, particularly small investors from losses other
than that of speculative nature arising out of default of member brokers of the
stock exchange.

It was held that the complainant investor would be a consumer
who is affected by the services provided by the share broker and therefore he
would be eligible to be paid from the fund of the Stock Exchange.

[Senior Manager, Delhi Stock Exchange & etc. v. Ravindar Pal Singh & Anr.,
AIR 2008 (NOC) 962 (NCC); 2008 (1) ALJ 560]

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Nirav Shah

Recovery of debts : Recovery of debts due to Banks and Financial Institutions Act : S. 19(7).

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13 Recovery of debts : Recovery of debts due
to Banks and Financial Institutions Act : S. 19(7).

The petitioner, his father and brother had jointly and
severally taken a loan from State Bank of India. On default the State Bank of
India initiated certificate proceedings against the three. At the time of
initiation of the proceeding itself the father and the brother had died. The
certificate was issued against all the three. The certificate officer later
dropped the proceedings and on appeal the collector remanded the matter back to
certificate officer to proceed against the petitioner.

On writ by the petitioner, it was held by the Court that the
certificate proceeding against the two dead person was void and unenforcecable.
But so far as the petitioner is concerned, the certificate issued was valid and
binding.

The loan was taken ‘jointly and severally’. The expression
‘jointly and severally’ implies their joint liability as well as individual for
entire loan amount. It was open for the creditor to proceed either against one
of the joint loanees or against all of them.

In view of the above the writ petition of the petitioner was
dismissed.

[Anand Mohan Singh v. State of Bihar & Ors., AIR
2008 Patna 53]

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Nirav Shah

Void Agreement : Tenancy Rights cannot be attached and auctioned — Consequent auction and sale certificate issued to purchaser would be void. Contract Act S. 24 and S. 65.

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14 Void Agreement : Tenancy Rights cannot be
attached and auctioned — Consequent auction and sale certificate issued to
purchaser would be void. Contract Act S. 24 and S. 65.

The defendant No. 2 is a private limited company and because
of non payment of income tax, the recovery officer had issued a proclamation
which was published in govt. Gazette for sale of the property. The property
included the business alongwith the tenancy rights of the defendants over the
disputed premises.

The original plaintiffs bid was accepted in the auction and
the later on he deposited the amount with the income tax department. Nobody had
taken any objection nor had applied for setting aside the same within 30 days
from the date of auction. The defent No. 1 through income tax officer issued
sale certificate in favour of the original plaintiff. The suit premises was
actually property of LIC and defendant No. 2 was a tenant over the same.

The income tax authorities failed to put the plaintiff in
possession of the suit premises. Therefore, the original plaintiff filed suit
for possession of the suit premises alongwith movable articles. The trial court
held that the sale certificate in favour of the plaintiff was illegal, null,
void and unenforceable in law.

Before the Court the plaintiff alternatively contended that
if the sale was illegal the Union of India (Income tax Dept.) was liable to pay
compensation to him or atleast refund the amount alongwith interest.

S. 23 of the Indian Contract Act provides that the
consideration or object of an agreement is lawful, unless it is forbidden by
law; or is of such a nature that, if permitted, it would defeat the provisions
of any law. S. 24 provides that if the consideration is for an object which is
unlawful, the agreement is void.

Transfer of tenancy is not permitted under the law and,
therefore the object of the auction being the sale of tenancy rights was
unlawful and, therefore, auction as well as the sale certificate are void and
unenforceable.

S. 65 of the Indian Contract Act provides that when an
agreement is discovered to be void, or when a contract becomes void, any person,
who has received any advantage under such agreement or contract is bound to
restore it, or to make compensation for it to the person from whom he received
it. In view of this clear legal position, income tax authorities, who had
received the consideration amount from the plaintiff for the contract of sale,
which turned out to be void, was liable to restore and refund the said amount to
the plaintiff.

The defendant No. 1 Union of India was liable to refund that
amount to the plaintiff with interest at the rate of 18% per annum from the date
of suit till the realization of the amount to the plaintiff.

[Smt. Chandan Mulji Nishar & Ors. v. UOI & Ors., AIR
2008 (NOC) 396 (Bom.); 2007 (6) AIR Bom R 698]

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Nirav Shah

Family arrangement or partition deed : For the purpose of stamping & Registration the contents of document are to be taken into consideration and not nomenclature — Transfer of Property Act; S. 5, Stamp Act, S. 35.

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12 Family arrangement or partition deed :
For the purpose of stamping & Registration the contents of document are to be
taken into consideration and not nomenclature — Transfer of Property Act; S. 5,
Stamp Act, S. 35.

The father and mother of the plaintiff owned properties
comprising of houses, shops and vacant sites and they died intestate leaving
behind the plaintiff and defendants as their legal heirs. The defendant
attempted to partition the properties with the help of local people and
panchayatdars which was not agreed to by the plaintiff. After prolonged
negotiation the defendants ultimately agreed for an amicable partition of
movable and immovable properties. When the plaintiff claimed for division of
ard
share the defendants resisted the same and the plaintiff filed the suit.

According to the defendant the agreement for partition was
reduced to writing before the panchayatdars and signed by the plaintiff and
defendants. The trial judge rejected the document produced by the defendants on
the ground that it was a partition deed and unless it is stamped and registered
the same cannot be admitted.

The Court held that to decide about the nature of a document
whether it requires to be stamped or to be registered, it is the contents of the
document, that are to be taken into consideration and not the nomenclature
alone.

The law is well settled that in cases where partition among
the joint owners had already taken place and the factum of the partition
effected earlier was put in writing on a later point of time and the properties
are enjoyed as per the said partition, the same can be termed as a family
arrangement and need not be treated as a partition deed and therefore, the
question of stamping and registering the same does not arise. On the other hand,
if an agreement itself creates a right for the first time as a document, then
one has to consider the contents of the agreement, instead of the nomenclature.
Merely because it is stated in the agreement that in respect of the gold, jewels
and silver utensils the same have already been divided among the family members
in the presence of panchayatdars, it does not mean that all other immovable
properties have also been divided already. A reading of the entire agreement
clearly showed that there was no recital to the effect that it was for recording
the earlier partition which had already taken place that the said agreement was
entered into. In that view of the matter, the said agreement cannot be marked as
a document, since it requires to be stamped and registered so as to be admitted
in evidence.

In this regard the Hon’ble Court relied on the Division Bench
decision in case of A.C. Lakshmipathy v. A. M. Chakrapani Reddiar & Ors.,
2001 (1) Law Weekly 257 wherein the legal position is summed up as under :

(a) “I. A family arrangement can be made orally.

(b) If made orally, there being no document, no question of
registration arises.

(c) If the family arrangement is reduced to writing and it
purports to create, declare, assign, limit or extinguish any right, title or
interest of any immovable property, it must be properly stamped and duly
registered as per the Indian Stamp Act and Indian Registration Act.

(d) If the family arrangement is stamped but not
registered, it can be looked into for collateral purposes.

(e) A family arrangement which is not stamped and not
registered cannot be looked into for any purpose in view of the specific bar
in S. 35 of the Indian Stamp Act.” and applying the above guidelines to the
facts of the case and contents of the document which is sought to be marked,
concluded that the agreement was purported to create, declare, assign, limit
and extinguish right, title and interest over the immovable properties and
therefore, the document was required to be properly stamped and duly
registered under the Indian Stamp Act and the Indian Registration Act.
Therefore, the document requires execution on proper stamp papers and
registration as per the Indian Registration Act.

[Vincent Lourdhenathan Dominique v. Josephine Syla
Dominique, AIR 2008 (NOC) 1173 (Mad.)]

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Nirav Shah

Audio CD admissible in evidence

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11 Audio CD admissible in evidence :

Evidence Act 1875 S. 65B

In a matrimonial proceeding for dissolution of marriage the
husband had produced an audio CD wherein the wife had abused and theatered the
husband on a cell phone which was recorded on audio CD and produced in Court.
The trial court admitted the audio CD as evidence; against the said order the
wife filed the present revision petition.

The petitioner wife had contended that the audio CD was
fabricated and inadmissible as evidence because the cell phone which was primary
evidence was not produced.

The Court dismissed the petition on the ground that the trial
court allowed the audio CD to be admitted reserving the right of the petitioner
to cross examine the respondent husband of its contents. The court directed the
trial court to consider the objection raised by the petitioner regarding
admissibility of the audio CD and decide the same.

[G. Shyamala Ranjini v. M. S. Tamizhnathan, AIR 2008
(NOC) 476 (Mad).]

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Nirav Shah

Worldwide Tax Trends Treatment of Tax Losses

No country stands immune to the global recession, even as the degree of its impact may vary. Companies world over are reeling under the brunt of declining revenues resulting in a consequential drop in bottomlines and even resulting in operating losses in some cases.

Though companies cannot often control the revenue or the top line in the current economic scenario, however, they may want to optimise the cash through cost control measures and efficient utilisation of incentives, such as tax losses.

In fact, some of the advanced tax jurisdictions provide for carry back of losses so as to utilise the available tax losses and thereby resulting in release of cash which is blocked in the form of taxes.

In the current times where several MNCs are facing the issue of operating losses (the term ‘operating losses’ for the purpose of this article denotes business losses) in various jurisdictions, it becomes imperative for them to evaluate the provisions on utilisation of tax losses in these jurisdictions so as to optimise the overall tax cost. Considering the above, this article contains a broad overview of provisions prevalent in certain key jurisdictions on utilisation of tax losses. However, it should be noted that there could be certain conditions prescribed under the respective tax laws which may need to be followed before offsetting the tax losses.

Before diving straight into the provisions prevalent in certain key jurisdictions on utilisation of tax losses, let us take a brief look at the relevant provisions prevalent in India.

India :

Indian tax laws provide for a distinction between operating losses and capital losses. In the year of losses, operating losses can be set off against capital income. However, capital losses can not be set off against the operating income.

Unutilised operating losses can be carried forward for a period of eight years to be set off against any future business income. Continuity of same business is not essential to set off carry forward operating losses.

Unutilised capital losses can be carried forward for a period of eight years to be set off against future capital gains. Indian tax laws classify capital gains as long-term capital gains or short-term capital gains depending on the period of holding of the capital asset. Accumulated long-term capital losses can be set off only against long-term capital gains and not against short-term capital gains. However, carry forward short-term capital losses can be set off against any capital gains i.e., long-term or short-term capital gains.

There are no provisions for carry back of tax losses to set off against the profit of earlier years.

Impact on carry over/utilisation of losses on change in ownership

Generally, Indian tax laws do not provide for any condition for continuity of ownership for utilisation of accumulated tax losses except in case of companies in which public are not substantially interested (i.e., Private Limited Companies).

In case of companies in which public are not substantially interested, there is a condition of continuity of a specified percentage of ownership in the year in which the losses are incurred and the year in which such losses are set off. There has to be a continuity of ownership of at least 51% in the year in which the losses are incurred and the year in which such losses are set off in order to set off accumulated tax losses.

Indian tax laws provide for carry over of tax losses to the resulting company in the event of business reorganisation viz. merger and demerger. In case of a merger which meets with the conditions specified under the Income-tax Act, the carry forward operating loss of the merged entity is rolled over to the surviving entity/resulting entity. However, there are certain specified conditions especially with respect to continuity of the merged business which need to be met, so as to avail the carry over benefit.

In case of demerger/hive-off, which meets the conditions specified in the Income-tax Act, the carry forward operating losses of the undertaking being hived off are transferred to the resulting company which can be set off against the profit of the resulting company. In the event, the carry forward operating losses do not pertain entirely to the undertaking being hived off, the carry forward operating losses of the demerged entity are allocated between demerged entity and the resulting entity on the basis of assets retained in the demerged entity and the assets transferred to resulting entity.

The provisions on continuity of ownership discussed hereinabove do not restrict the carry over of operating losses in case of the aforesaid reorganisation.

Transfer of losses to other group entities

Indian tax laws do not contain provisions for surrender/transfer of losses to other group entities for set off against their profit. In effect, Indian tax laws do not contain any provisions for group consolidation. Each of the group entities needs to file its tax return separately.

After evaluating the provisions under the Indian tax laws, let us now look at the provisions on utilisation of tax losses prevalent under certain key jurisdictions.

United States (US) :

Generally, US tax laws provide for a distinction between operating losses and capital losses. In general, capital losses can be set off only against capital gains and not ordinary income. Capital losses can be carried back for three years and carried forward for five years to be set off against capital gains in such years.

Operating losses can be carried back two years and forward twenty years to offset taxable income in those years. Operating losses can be set off against business income as well as capital gains.

Impact on carry over/utilisation of losses on change in ownership

There is a limitation on the amount of operating losses that can be utilised to offset against taxable income on ownership change. This limitation is provided in Section 382 of the Internal Revenue Code (IRC). Generally, an ownership change occurs when more than 50% of the beneficial stock ownership of a corporation in loss had changed hands over a prescribed period (generally three years). The three-year period can be shortened to the extent that the losses were incurred within the three year period or there was an ownership change within the three year period. Thus, Section 382 Limitation effectively prevents shifting of unfettered loss deduction from one group of corporate owners to a new group.

Generally, the limitation amount equals the value of the stock of the corporation immediately before the ownership change, multiplied by the long-term tax exempt rate. The long-term exempt rate changes monthly and is published by the Internal Revenue Service in the Internal Revenue Bulletin. Losses that cannot be deducted in a particular tax year due to aforesaid limitation can be carried forward.

In case of business reorganisation i.e., merger, generally, all the tax attributes of the merged corporation, induding net operating losses, transfer to the surviving corporation in a tax-free merger. The surviving corporation in a statutory merger can carry forward the net operating losses of the absorbed companies to reduce its taxable income in twenty subsequent tax years from the tax year in which the loss was incurred. Net operating losses can be carried back two years. Generally in case of merger, the net operating losses are not ‘ring fenced’. Such losses can be utilised against the income from business of the merged entity and the merging entity. However, such losses can not be offset against the income from business of the existing subsidiary of the resulting entity in case of consolidation. The limitation rules as discussed hereinabove would equally apply if there is a change in the ownership beyond a specified percentage pursuant to merger.

Transfer of losses to other group entities

US tax laws provide for group consolidation on fulfilment of certain stock ownership criteria. An affiliated group of US corporations may elect to determine its taxable income and tax liability on a consolidated basis.

Losses incurred by members of a group during the period of consolidation can be used to offset profits of other members of the group. However, losses incurred by a corporation prior to joining the group, referred to as separate return limitation year losses (SRLY losses), may not be used to offset profits of other group members or be carried back by such members to pre-consolidation taxable years. The SRLY loss rules also apply to built-in losses, i.e., losses realised during the first five years of consolidation to the extent attributable to assets with a value below adjusted tax basis at the time the member joined the group.

United Kingdom (UK) :

UK tax laws provide for a distinction between operating loss/trading loss and a capital loss. Generally, capital loss can be offset against capital gains of the same accounting period or can be carried forward indefinitely. However, capital loss cannot be carried back. Capital loss cannot be used to reduce the trading profits.

A trading loss incurred by a company in any accounting period may be set off against the total taxable profits (including capital gains) of the period and against the total taxable profits of an immediately preceding period, provided the same trade was then carried on. Losses can also be carried forward indefinitely for relief against future income from the same trade. Thus, losses can be set off only against the future profit from the same trade. Considering the above, a company with several trades or businesses may be required to keep separate accounts for each trade or business.

A company that ceases trading can carry back trading losses and offset them against profit of previous thirty-six months.

Impact on carry over/utilisation of losses on change in ownership

There is an important restriction on the carry-over of trading losses on a merger or acquisition if within any period of three years there is both a change in the ownership of a company and a major change in the nature or conduct of the trade carried on by the company to which the losses relate.

In case of change of ownership of the company and a major change in the nature or conduct of the relevant trade within a three-year period, trading losses otherwise available for carry forward are forfeited with effect from the date of the change of ownership.

Similar restrictions on the carryover of losses also apply if, at any time after the scale of activities in the trade carried on by the company has become small or negligible and before any considerable revival of the trade, there is a change in the ownership of the company.

The crucial issues that need to be considered in determining whether the above restrictions on the carry-over of trading losses apply on a merger or acquisition are: firstly whether there is a change of ownership and secondly whether or not there is a major change in the nature or conduct of the trade. There are specified provisions which define change of ownership for aforesaid purpose. The change of ownership is disregarded when the ownership is merely transferred between members of a 75% group.

The circumstances where there will be a major change in the nature or conduct of the trade for the purposes of these provisions are not exhaustively defined in the legislation. However, there are some indicative factors which can be used as reference to determine whether there is a major change in the nature or conduct of trade.

Transfer of losses to other group entities

UK tax laws do not provide for tax consolidation. However, a trading loss incurred by one company within a 75% owned group of companies may be grouped with profits for the same period realised by another member of the group.

Germany:

German corporate tax laws do not provide for distinction between operating losses and capital losses. Capital losses are generally deductible.

However, capital losses resulting from transactions which are exempt from tax are not deductible. In particular, this rule applies to capital loss from sale of shares or from write-down on shares. This, effectively, means that the capital loss on sale of shares is not tax deductible.

Net operating losses of up to EUR 511,500 may be optionally carried back for one year prior to the year in which the losses have been incurred for corporate tax purposes. Remaining tax losses can be carried forward indefinitely. However, the amount of loss carried forward is restricted to EUR 1 million of net income in a given year. Any remaining loss can only be set off against up to 60% of the net income exceeding this limit. This essentially means that 40% of the net income exceeding Euro 1 million is subject to tax even if there are available tax losses (so-called minimum taxation). There is no condition of continuity of same business to set off accumulated tax losses.

Impact on carry over/utilisation of losses on change in ownership

The 2008 Business Tax Reforms introduced new rules regarding the treatment of tax losses on changes of ownership in the loss company. These rules are effective from 1 January 2008. Under the new rules, tax losses expire proportionally if, within a 5-year period, more than 25% of the shares of a loss entity are directly or indirectly transferred to one acquirer or an entity related to such acquirer. If more than 50% of shares are transferred within a 5-year period, the entire tax losses will be lost. The new rules include a measure under which investors with common interests acting together are deemed to be one acquirer for the purpose of these rules.

The German Bundesrat Committee has proposed some changes to the loss carry forward limitation rules. The proposed rule includes an insolvency restructuring exception. Under the restructuring exception, a change in ownership would not result in forfeiture of a loss carry forward if :

i) the transfer of shares in a loss corporation is part of a plan to make the loss corporation solvent, and

ii) the plan preserves the ‘structural integrity’ of the loss corporation’s business. A preservation of structural integrity is deemed to exist if :

o there is an agreement with the German Workers’ Council of the loss corporation
concerning the preservation of jobs and that agreement has been honoured; or

o the company continued to pay a certain amount of gross salaries over a period of five years following the change in own:rship; or

o the shareholders made significant contributions to the equity of the loss corporation.

The insolvency restructuring exception would not apply if the loss corporation’s business was already shut down at the time of the share transfer, or if during a period of five years following the share transfer the loss corporation discontinues its historic business and engages in a different business sector.

Under the proposal, the insolvency restructuring exception would become effective for the year 2008
and would apply (also retroactively) to all ownership changes that occurred between December 31, 2007, and December 31, 2010.

In the event of business reorganisation e.g., merger, carry forward tax losses of the transferring entity are forfeited and cannot be further used by the receiving entity.

In the event of a spin-off wherein a part of the business is hived off into a separate company, carry forward tax losses relating to the business which is transferred is generally forfeited. However, carry forward tax losses relating to the existing business which has not moved will remain intact and can be utilised subject to German change of ownership rules discussed hereinabove.

Transfer of losses to other group entities

German tax laws provide for the filing of a consolidated tax return for a German group of companies which allow losses of group companies to be offset against profits of other group companies. The German parent company must file

the consolidated tax return. Only German companies in which the German parent company holds the majority of the voting shares at the beginning of the fiscal year of the subsidiary can be included in the group consolidation. In order to achieve group taxation, a profit and loss pooling agreement must be concluded. The profit and loss pooling agreement requires that the controlled company transfers all its profits to the controlled parent and that the controlling parent actually covers the losses of the controlled company.

Losses of controlled company incurred prior to group taxation cannot be used for corporate income tax purposes as long as group taxation applies. Such losses can be offset against the future profits of the controlled company after group taxation has ended.

Australia:

Australian tax laws provide for distinction between capital loss and business loss. Capital losses are calculated using the reduced cost base of assets without indexation for inflation. Capital losses are deductible only against taxable capital gains and not against ordinary income. Capital losses can be carried forward indefinitely to be offset against taxable capital gains in future. Capital losses cannot be carried back.

Operating loss is excess of allowable deductions over assessable and exempt income for a particular year. Operating loss can be carried forward indefinitely to be offset against taxable income derived during succeeding years. Operating loss can be offset against both operating income as well as capital gains. Operating losses cannot be carried back.

Impact on carry over/utilisation of losses on change in ownership

Companies must satisfy greater than 50% continuity of ownership tests for voting power, rights to returns of capital and dividend rights (COT) in order to deduct its prior year losses. Where continuity is failed losses can be deducted if the same business is carried on in the income year (the same business test). Thus, if there is a change in ownership, prior year losses can be offset provided the same business is being carried on in the year in which the prior year losses are set off. The aforesaid tests are applied with modification in the event losses are utilised on group consolidation.

Transfer of losses to other group entities

A wholly-owned group of Australian companies can choose to consolidate for income tax purposes. Where a consolidated group is formed, the group is treated as a single entity during the period of consolidation. The subsidiary entities lose their individual tax identities and are treated as part of the head company for the purposes of determining income tax liability.

Under the tax-consolidation regime, the carry forward losses of companies forming part of a consolidated group may be used by the consolidated group, subject to the limitation-of-loss rules, which limit the amount of losses that can be used, based on -a proportion of the market value of the loss-making company to the consolidated group as a whole.

Generally, losses can be transferred to the group only if the losses could have been used outside the group by the entity seeking to transfer them. Once a subsidiary member of a group transfers a loss, it is no longer available for use by the subsidiary, even if the subsidiary subsequently leaves the group.

China:

Generally, Chinese tax laws do not provide for any distinction between operating losses and capital losses. Under the Enterprise Income Tax Regulation (EITR), losses are allowed to be carried forward for a maximum of five years without any restriction. However, losses may not be carried back.

Impact on carry over/utilisation of losses on change in ownership

Generally, there is no restriction on utilisation of accumulated tax losses in the event of change in ownership. The company can set off the accumulated tax losses even if there is a change in the shareholding of the company.

In the event of merger, the amount of losses of the pre-merger entity can be rolled over to the surviving entity provided the merger qualifies under Special Restructuring (SR) defined under the corporate tax laws. The quantum of loss that can be rolled over is confined to ‘x’ times the fair value of pre-merger entity, where ‘x’ is the interest rate of the longest-term national debt issued in that year.

Transfer of losses to other group entities

There is no group consolidation provision in China. Accordingly, losses of one group entity in China cannot be set off against the profit of another group entity.

Conclusion

While most of the advanced economies provide for carry back of losses and transfer of losses within the group entities through the group consolidation mechanism, these provisions are not yet incorporated under the Indian tax laws. India today is no longer an isolated economy. It is aligned and integrated with the world economy. Further, in the current economic downturn wherein companies globally are facing heavy pressure on margins resulting in operating losses in some cases, it is just that companies are given the benefit of utilising losses against their prior year profits and also against the profit of other group entities. Further, in the current scenario where Indian companies are facing liquidity crunch, it is essential that aforesaid provisions are implemented in the Indian tax code so that companies can optimise on cash through effective utilisation of tax losses. Considering this, time is now ripe that India adopts the well-accepted international tax concept of provision of carry back of loss and group consolidation in its tax code.

For comparative purpose, the key provisions on utilisation of tax losses in key jurisdictions are tabulated below:

Nirav Shah

Consolidated FDI policy-2010

Article

1. The Ministry of Commerce and Industry has issued a
‘Consolidated FDI Policy’ effective from 1st April, 2010. (Circular 1 of
2010)

The policy has consolidated into one document the entire
policy on foreign direct investment spread over various Press Notes. The past
Press Notes are rescinded. A fresh consolidated policy will be issued every six
months.

Though it states that there are no new measures in the
policy, there are a few provisions which did not exist earlier. In this article
I have mainly covered those issues which were not discussed earlier, and those
where there is additional or more clarity. I have covered the basic policy
provisions very briefly.

2. Basic FDI policy :

The basic policy for FDI is that foreign investment is freely
permitted in all sectors in India — except where there is a restriction. In some
sectors, FDI is totally prohibited like agriculture, retail trade, real estate,
etc. In some sectors, there are some conditions like NBFC, Construction and
Development, etc. However by and large, investment is freely permissible. On
investment, some compliances have to be completed.

If the investment is not under the automatic route, an
approval from FIPB or SIA is required.

Non-residents are required to invest at a price which is at
least equal to the value as per erstwhile CCI guidelines.

Transfer of shares is also under automatic route — subject to
compliance of the conditions laid down.

3. Legal background :

In the past, the foreign investment policy was issued as a
part of Industrial Policy. The Industrial Policy dealt with licensing and other
issues. Over a period by 2003, the Government titled the document as Foreign
Investment Policy, etc. In actual practice, ‘Industrial Policy’, ‘Foreign Direct
Investment Policy’, ‘Foreign Investment Policy’ have been used interchangeably.
There has never been a ‘Foreign Direct Investment Policy’ as such.

3.1 The Consolidated FDI policy has not been issued under any
law. It is a policy issued by the Department of Industrial Policy and Promotion
(DIPP) which is under the Ministry of Commerce and Industry.

DIPP issues Press Notes for amendments to the policy. The
legal framework is the Foreign Exchange Management Act and the regulations
issued under it. FEMA regulations lay down the law, and procedures. For Foreign
Direct Investment, FEMA Notification 20 is applicable. Generally the RBI issues
Notifications to amend the regulations in line with the Press Notes issued by
DIPP. However where the RBI has some differences or requires some
clarifications, FEMA regulations does not get amended.

On a few issues, there are differences between the FDI policy
and FEMA regulations.

3.2 Clause 1.1.9 of the Consolidated FDI policy states that
“The Circular consolidates FDI policy framework, the legal edifice is
built on Notifications issued by the RBI under FEMA. Therefore, any changes
notified by the RBI from time to time would have to be complied with and where
there is a need/scope of interpretation, the relevant FEMA notification will
prevail.”

This is for the first time that a document states that it is
FEMA regulations which have the legal binding force. This is a clear provision
which is good. Where the Press Note (or Consolidated FDI policy) liberalises any
provision till the FEMA notification is amended, the liberalisation will not
have any effect. In such situation, one can approach the RBI with an
application. Generally the RBI would grant an approval, unless it has some
differences with DIPP on the liberalisation measures.

3.3 Clause 1.1.4 states that “the regulatory framework over a
period of time thus consists of Acts, Regulations, Press Notes, Press Releases,
Clarifications, etc.”. Thus according to DIPP, all communication from the DIPP
are a part of regulatory framework ! At times, there are clarifications given by
Ministers, or by DIPP on its website. Would they be a part of legal framework ?

It will be interesting to read the decision of Federation of
Associations of Manufacturers referred to in paragraph 6. The Delhi High Court
has said in case of policy matters, the Government is free to decide the meaning
it wants to adopt for various terms. In that case, the Government had adopted a
modern meaning of wholesale trading compared to the traditional meaning. That
time the meaning was not in the public domain. The Government gave its view by
way of an affidavit to the Court. The issue is that the Government can be more
upfront in providing its view.

3.4 FEMA Notification No. 20, states the following in
Schedule I, clause 2(1) :

“An Indian company, not engaged in any activity/sector
mentioned in Annex A to this schedule, may issue shares or convertible
debentures to a person resident outside India, subject to the limits
prescribed in Annex B to this schedule, in accordance with the Entry
Routes specified therein and the provisions of Foreign Direct
Investment Policy, as notified by the Ministry of Commerce and Industry,
Government of India, from time to time.”

As mentioned above, there has never been any Foreign Direct
Investment Policy as such. There has been an ‘Industrial policy’. Practically,
the document published by the Ministry of Commerce and Industries has been
referred to as the FDI policy.

3.5 The Consolidated FDI policy states that in cases of
interpretation, FEMA Notification will prevail. FEMA notification states that
investment will be permitted as per the limits stated in the schedule and the
FDI policy.

Which prevails — FEMA regulations or FDI policy ?

Take an example :

Chapter 4 of the Consolidated FDI policy lays down the policy
for deciding whether an Indian company is controlled and owned by Indian
residents and citizens. (Earlier the policy was laid down in Press Notes 2, 3
and 4 of 2009. These Press Notes now stand rescinded.) It states that if the
Indian company in which there is foreign investment is owned or
controlled by non-residents to the extent of 50% or more, it will be
considered as foreign investment. Any investment by such a company in another
Indian company will be considered as foreign investment. Sectoral caps will
apply.

Vice-versa, if the Indian company is owned and controlled
by persons who are Indian residents and citizens to the extent of more than 50%,
it will be considered as Indian investment. Investment by such a company in
another Indian company will not be considered for counting foreign investment.

A chart is given below to illustrate the issue :

Thus the Foreign Co. (F) owns directly and indirectly [through the JV Co. – (J)] total capital Rs.6,226 (3,626 + 2,600) of 62.26% in Defense production company (D).

In defence sector, foreign investment cannot exceed 26%. With the above structure, the investment can exceed 26%, although the control will be with the Indian Co. – I.

Is this permitted ?

A plain reading of FDI policy gives an impression that it is permitted. Investment in the above manner can take places in several sectors where there is a restriction or a sectoral cap.

However these provisions have not been enacted in FEMA regulations.

This is a situation where FDI policy is more liberal than the FEMA regulations.

The Consolidated FDI policy states that if there is any interpretation issue, FEMA will prevail. As such a provision is not there in FEMA, the investment cannot be made.

Under FEMA, it states that the investment is subject to provisions of the FDI policy. Can we say that the investment can be made ?

In my view, as the Consolidated FDI policy clearly states that FEMA will prevail, the investment cannot be made. (Also see paragraph 3.11.)

3.6 Take a situation where FEMA is more liberal than the FDI policy.

All sectors where there is no restriction, foreign investment can be made freely. Services sector is under automatic route under FEMA.

Under the erstwhile FDI policy before 31-3-2010 also, services sector was under automatic route.

The Consolidated FDI policy now states under clause 5.20 that FDI is allowed in specified ‘Business services’. Does this mean that other services are now no longer under automatic route ? (See paragraph 9.1 also for more discussion.)

3.7 Is it possible to take a view that only if the Consolidated FDI policy and FEMA regulations both permit, then only investment can be made ?

My personal view is as under :

Where FEMA permits an investment on automatic basis, a non-resident can make the investment. Where the FDI policy permits an investment, but FEMA does not permit it, then one needs to take an approval from the RBI/FIPB before making the investment.

3.8 Consider a situation where the non-resident wants to invest in ‘Cash and carry/Wholesale trading’. It is an activity which is permitted on automatic basis.

There were however controversies on the meaning of ‘Cash and carry/Wholesale’. One of the controversies was that whether goods sold on credit will be in line with ‘Cash and carry’. FEMA regulations do not explain the meaning of ‘cash and carry’. The Consolidated FDI policy now explains the meaning of this term. It states that normal credit terms can be given to the customers.

Thus investment can be made in this sector and normal credit can be extended to the customers. (See paragraph 6 for more discussion.)

Thus where FEMA is ‘silent’ on the meaning of any term, one should be able to rely on the FDI policy. In the case of Federation of Associations of Manufacturers, the Delhi High Court has stated that such issue is a policy matter. The Government is within its rights to formulate policy matters. If the Government decides to adopt a particular meaning of any business phrase, it can do so. If the Government has considered that normal credit terms are permissible, then the same are permissible.

3.9 Therefore in a situation where there is a clear conflict between FDI policy and FEMA, FEMA will prevail. Where it is an issue of understanding of particular terms, the clarification given by DIPP or FEMA will prevail.

3.10 One may appreciate that Consolidated FDI policy by DIPP is a policy level document, whereas FEMA is the legal document. Both have different objectives. The Consolidated FDI policy can be considered as the intention of the Government, whereas FEMA lays down the detailed rules. Unless a policy is enacted as a statute, it does not have the force of law.

3.11 With the FDI policy, a press release has also been issued. One of the paragraphs in the press release states that — “There are a number of issues related to FDI policy that are currently under discussion in the Government, such as foreign investment in Limited Liability Partnerships (LLPs), policy on issuance of partly paid shares/warrants, rescinding Schedule IV of FEMA, clarifications on issues related to Press Notes 2, 3 & 4 of 2009 and on Press Note 2 of 2005, as also certain definitional issues, etc. When a decision on these is taken, the Government decision would be announced and thereafter incorporated into the Consolidated Press Note subsequently.”

Thus there is recognition that there are some issues on which the Government thinking has still not been finalised.

In my view, Press Notes 2, 3 and 4 of 2009 are not operational as far as the automatic route is concerned. One can approach FIPB for a specific approval.
The Government is considering to scrap non-repatriable category of investment for NRIs. One will have to wait for the announcement.

Investment in an LLP is desirable. There will be issues of partners’ investment in capital, withdrawal of the same, payment of interest, etc.

Let us consider some specific issues dealt with by the FDI policy which have not been dealt with earlier.

4. Investee entity :
A non-resident can invest in an Indian company (on automatic basis). An NRI can invest in an Indian company on repatriable basis and non-repatriable basis. An NRI can invest in a partnership firm or a proprietory concern on non-repatriable basis. This policy continues under the Consolidated FDI policy.

Investment in other entities was not permitted. Now the Consolidated FDI policy is more specific.

4.1 Investment in partnership firm on repatriable basis :
Normally investment in partnership/proprietory concern is not permitted on repatriable basis. The only sector where there is a reference of investment in a firm is the defence sector (Press Note 2 dated 4-1-2002 and entry 5.9 of Consolidated FDI policy). The RBI had issued a Circular No. AP 39, dated 3-12-2003. As per the Circular, NRIs could invest in a partnership firm or a proprietory concern on repatriable basis after obtaining an approval from Secretariat of Industrial Approvals/RBI. The Circular also provides that persons of Non-Indian origin can invest in a partnership firm or a proprietory concern after obtaining an approval from the RBI.

In actual practice, the RBI is not granting any approval for repatriable investment in a partnership firm and proprietory concern.

The Consolidated FDI policy now provides that NRIs and persons other than NRIs can apply to the RBI [para 3.2.2]. The application will be decided in consultation with the Government of India. This is the first time that the FDI policy provides for a foreigner to invest in a partnership firm/proprietory concern. The criteria however has not been specified. One will have to wait and see whether the RBI/Government permits investment in a firm/proprietory concern and on what terms and conditions.

4.2 Trusts :

Para 3.3.3 prohibits FDI in trusts other than Venture Capital Fund (VCF). Investment in trusts was in any case not permitted. However, let us consider some issues.

4.2.1 Can an NRI or an FII invest in mutual funds which are formed as trusts ? So far they have been permitted to invest (Schedule 5 of FEMA Notification 20).

4.2.2 An NRI wants to set up a private trust in India. The trust is for his family members. Some beneficiaries are NRIs and some are Indian residents. The NRI settlor himself can be a beneficiary.

Can such a trust be settled ? Will such a settlement be considered as an ‘investment’ ?

At the outset one may observe that ‘settlement’ cannot be considered as ‘investment’. However there will be a transfer of assets to the Indian trust where a non-resident will have an interest. It requires an approval from the RBI. Now with a specific bar under the FDI policy, will it be possible to have an Indian trust with non-residents as beneficiary ? Will the RBI consider an application at all ? One will have to wait and watch.

The above situation is different from a situation where a non-resident wants to invest in the Indian economy through a trust. Consider a situation where an NRI settles funds in an Indian trust. The trust will have an NRI as a beneficiary. The trust will undertake portfolio investment/business activities. This is not permitted.

4.2.3 The personal status of the trust (whether it is a person), and its residential status are existing issues under FEMA. These are however beyond the scope of this article.

4.3 Other entities :
FDI is not permitted in other entities. Thus investment in Association of Persons is not possible.

A non-resident and an Indian resident have to jointly bid for a contract. The bidding may be done jointly. They may be even awarded the contract jointly. This is clearly permitted. Under the Income-tax Act, it may become an AOP. That is a different matter.

As long as there is no ‘investment’ to be made in the AOP, there is no restriction. In this kind of AOP, the parties only carry out the work jointly. The finances are independently managed by the investors. This is clearly permitted. As far as the non-resident is concerned, he may have to comply with the ‘project office’ rules.

If however the non-resident wants to ‘invest’ in the AOP, then it is prohibited.

5. Securities in which the non-resident can invest in :

5.1 Convertible debentures and preference shares :

5.1.1 Prior to 1-5-2007, Indian companies could issue debentures and preference shares to non-residents which were partly or fully convertible into equity shares.

There were different views on how much of the face value could be converted into equity shares. Different offices of the RBI had given varying views on the amount which had to be converted into equity shares (ranging from 10 to 25% of the face value). However DIPP had a different view. According to DIPP, even if 1% of the face value was converted into equity shares, it was acceptable. With such an instrument, it was possible for a non-resident to invest in partly convertible debentures (PCDs) or partly convertible preference shares (PCPs). By having an option to convert only 1% of the face value, the investor could participate in the debt in India. Without the PCDs, it was difficult to participate in the debt.

India received a lot of foreign exchange in the form of FDI, ECB, and portfolio investment. The economy started heating up in 2007. Hence the Government banned partly convertible debentures and partly convertible instruments.

Only fully convertible debentures (FCDs) and fully convertible preference shares (FCPs) are now permitted.

5.1.2 There is however an issue of the price at which the FCDs and FCPs can be converted.

The basic policy is that Non-residents are required to invest at a price which is at least equal to the value as per erstwhile CCI guidelines (referred to as the ‘minimum price’). Therefore at what price the convertible debentures/preference shares should be converted. (This was an issue even when PCDs or PCPs could be issued.)

Broadly, there can be different alternatives for the price at which the instruments can be converted. These can be as under :
   i) The price of conversion could be the ‘mini-mum price’ of equity shares at the time of issue of FCDs/FCPs. It could be at face value in case of a new company or at a ‘minimum price’ in case of an existing company. This is the minimum price at which the non-resident has to invest.
   ii) The price of conversion could be decided at the time of conversion.
   iii) The third alternative is a variation of the second alternative. The basis of the price could be decided upfront depending on the profits which the company earns. The conversion period could also be a range of dates. It need not be a fixed date. The actual price could be worked out later. As in the second alternative, the ‘minimum price’ of conversion would be decided at the time of conversion.

5.1.3 The RBI held a view that the price could not be determined at the time of issue. It had to be determined at the time of conversion. Their argument was that if at the time of issue the prescribed price was Rs.10, and at the time of conversion after 3 years, the price was Rs.20, the non-resident must get the shares at Rs.20.

Recently at a conference, we were told that the price was to be decided upfront at the time of issue. This was the understanding from 2007 when PCDs and PCPs were banned ! In my view, when PCDs and PCPs were banned, there was nothing in the press releases and Circulars on the pricing issue.

5.1.4 The FDI policy states in clause 3.2.1 that the pricing of the capital instruments should be decided/ determined upfront at the time of issue of the instruments. Does this have any significance?

Does the ‘minimum price’ have to be determined at the time of issue ? Or only the basis for the ‘minimum price’ has to be determined ?

Does it have to be an exact amount, or can it be determined with reference to a basis like price to earnings ratio ?

The FDI policy states that the ‘pricing’ shall be decided/determined at the time of issue. ‘Pricing’ is a broader term. It is different from the term ‘price’. Pricing means basis of the price and not a certain number. Therefore if the basis of the price is determined, but the actual price is determined later, the condition should be considered as complied with.

However the RBI does not appear to have this view.
Let us consider an example below.

5.1.5 The ‘minimum price’ could be as under :

At the time of issue

Rs.
10

At the time of conversion into equity

Rs. 20

From investors’ point of view, there could be bona fide reasons for conversion at a ‘minimum price’ on the date of issue of FCDs/FCPs. They would consider their appreciation from the date of investment.

If the ‘minimum price’ is decided at the time of issue, then the investor will benefit. Consider further that the investor may receive interest on FCDs till the same are converted. In this situation, the investor will get interest, as well as the benefit of conversion at a lower price.

From issuer’s (investee company’s) point of view, there could be bona fide reasons for conversion at a ‘minimum price’ on the date of conversion of FCDs/ FCPs. If the ‘minimum price’ is higher at the time of conversion, the Indian company would not like to give away the shares at a lower price.

This issue has become a grey area. It requires more clarification from the RBI/Government.

In the share purchase agreements, it is advisable to provide that the price at which the FCDs/FCPs will be converted will be on a particular basis; however it will not be less than the price prescribed as per regulations under FEMA.

5.2 Prohibitions :
Apart from the FCDs and FCPs, no other instrument can be issued. It has been specifically stated that warrants and party paid shares cannot be issued.

6. Trading :

6.1 FDI in trading activities is primarily prohibited. However trading for exports, Cash and Carry trading/ Wholesale trading (WT), single brand retail trading is permitted. (Press Note 4, dated 10-2-2006/clause 5.39 of Consolidated FDI policy.)

6.2 It will be interesting to note the meaning of ‘Cash and Carry’ as understood internationally.

The business format of cash and carry includes the following characteristics :
— The seller sells on cash.
— Seller does not provide delivery services. The purchaser takes the goods himself. This is a major distinction between normal wholesale trading and cash and carry wholesale trad-ing.
— The volume of trade is not relevant. What is relevant is type of customer — whether he uses the goods for business, or for personal consumption. The customer should use the goods for business.

6.3 This understanding was never explained by the Government in the past. Initially there were several issues on which there was no clarity. Over time however some issues were clarified on the website of DIPP, or by way of clarification from DIPP on a specific request.

The meaning of WT as understood by DIPP is :
— The sale should be to a person who has sales tax number/VAT registration.
Say a hospital wants to buy medical sutures on wholesale basis. The hospital has registration numbers, under various Government authori-ties. Yet it is the ultimate consumer. Whether this was permitted or not was not clear.

— Sale should not be to an end user. i.e., The sale should be to an intermediary like distributor, etc.
— Sale should be on cash basis. Whether normal credit period as prevalent in the industry was permitted or not was not clear. On a specific request, DIPP clarified that normal credit pe-riod was permissible.

Subsequently, the Federation of Associations of Manufacturers had filed a writ petition in the Delhi High Court. In that case, the Government has given its understanding on the meaning of the term ‘Wholesale Cash and Carry trading’. The writ petition was filed mainly because the Government had permitted non-resident investment in B2B e-commerce. The Delhi High Court had said that this is a policy matter. If the Government in its wisdom adopts a modern meaning of ‘wholesale trading’ against a traditional meaning, then it is right in doing so.

6.4 The Consolidated FDI policy now explains this issue elaborately in clause 5.39.1.1. The important clarifications which the policy provides are as under :

— Sale of goods can be to distributors or inter-mediaries, and also to institutions and other professional business users. Thus the Indian company can sell computers in bulk to a person who wants to purchase them for office use.
The sale cannot be for personal consumption of the retail buyer.

Can sale take place to an individual Chartered Accountant in practice who will purchase, say, one box of papers for printing in his office ? Clearly this is permitted. The policy clarifies that — “The yardstick to determine whether the sale is wholesale or not would be the type of customers to whom the sale is made and not the size and volume of the sale.”

Thus essentially sale to end user for personal consumption is not permitted. Sale for busi-ness use is permitted.
Is a sale to a charitable trust or a hospital or an educational institution permitted ? Again the answer is that as these organisations will pur-chase for consumption during the course of their activities, the sale can be undertaken.

— The policy provides for guidelines as under :
a) All necessary approvals from Central/ State/ local Government should be obtained by the wholesaler.

   b) Sale to Government is permitted. Sale to person other than the Government will be permitted only when the ‘buyer’ fulfils any one of the following conditions :
   i) The buyer holds sales tax/VAT registration/service tax/excise duty registration; or
   ii) The buyer holds trade licences i.e., a licence/registration certificate/membership certificate/registration under the Shops and Establishment Act, reflecting that the buyer is itself engaged in a busi-ness involving commercial activity; or

iii) The buyer holds permits/licence, etc. for undertaking retail trade (like tehbazari and similar licence for hawkers); or

iv) The buyer is an institution having certificate of incorporation or registration as a society or registration as public trust for its self consumption.

c) Full records of the purchasers including their registration/licence/permit, etc. should be maintained on a day-to-day basis.

d) WT of goods is permitted among group companies. However, there are further conditions :

— such WT to group companies taken together should not exceed 25% of the total turnover of the wholesale venture.

— the wholesale made to the group com-panies should be for their internal use only.
However, say, for example, if the whole-saler proposes to sell the goods to a group company which is a retailer. Can it be done ? This is clearly a permitted transaction. It cannot be a situation that the wholesaler can sell goods to a 3rd party retailer, but not to its own group company which is a retailer. It is only if the sale to group company is for internal consumption that there is a restriction. However the manner in which the restric-tion has been provided, it seems that sale to group company is permitted only for self-consumption.

e) WT can be done as per normal business practice. Credit facilities as per normal business practice can be given, subject to applicable regulations.

f) A Wholesale/Cash & carry trader cannot open retail shops to sell to the consumer directly.

7. NBFC activities :
NBFC activities are permitted under automatic route. There are capitalisation norms for such companies. For fund-based activities, in case the non-resident investor wants to invest up to 100% of the equity capital, the minimum capital required to be brought in is US$ 50 mn.

For non-fund-based activities the capitalisation is US$ 0.5 mn. The Consolidated FDI policy now has stated that the following activities will be considered as non-fund based activities :

   a. Investment Advisory Services.
   b. Financial Consultancy.
   c. Forex Trading.
   d. Money Changing Business.
   e. Credit Rating Agencies.

8. Transfer of shares :
Transfer of shares from an Indian resident to a non-resident is generally under automatic basis. [AP Circular 16, dated 4th October 2004 read with other Circulars]. However if the Indian company is engaged in financial services, and the transfer is from an Indian resident to a non-resident, automatic route is not available.

8.1 DIPP had issued a Press Note No. 4, dated 10-2-2006 stating that transfer of shares of an Indian company engaged in financial services sector will be on automatic basis.

However the RBI had not agreed to that issue. Therefore when the RBI issued the Notification No. 179, dated 22-8-2008 (with effect from 10-2-2006 — the date of DIPP Press Note No. 4), it still provided that automatic route is not available if the Indian company is engaged in financial sector.

Now the FDI policy again states that if the Indian company is engaged in financial services sector, automatic route will not be available.

8.2 The RBI has issued the Notification No. 131, dated 17-3-2005. It has defined ‘financial services’ as ‘service rendered by banking and non-banking companies regulated by the Reserve Bank, insurance, companies regulated by Insurance Regulatory and Development Authority (IRDA) and other companies regulated by any other financial regulator as the case may be.’ The Notification (No. 131) was issued with effect from 16-10-2004 (the date of issue of AP Circular 16, dated 16-10-2004).

Thus if the company is regulated by a financial regulator, automatic route will not be available.

9. Business services :
Clause 5.20 provides that FDI up to 100% is permitted for business services under automatic route. However it states that FDI is allowed in “Data processing, software development and computer consultancy services; Software supply services; Business and management consultancy services, Market research services, Technical testing & Analysis services.”

Does this mean that FDI is not allowed in other business services ?

This kind of a clarification was not provided in FDI policy earlier. It is also not provided in FEMA Notification.

This cannot be the intention. Any sector where there is no restriction, is freely permitted (clause 5.41 of FDI policy). FDI in service sector has been permitted on automatic basis except in the areas where there is a sectoral cap (like courier services, ground handling services at airports, telecom services, etc.).

In any case, FEMA prevails in case of interpretation issue. Therefore in my view, FDI is freely permitted in ‘services sector’.

See paragraph 2 on the basic FDI policy.

10. In a nutshell it is a good attempt to provide the entire policy in one document. To refer to various Press Notes spread over a few years is difficult. Some issues will always remain. Over time, these should be sorted out.

Nirav Shah

The Finance Act, 2008

Nirav Shah

Redevelopment — Belated withdrawal of No objection or consent and opposition to eviction by society member — Not proper — BMC Act, 1888, MHAD Act, 1976 S. 75 and S. 95A.

New Page 1

[Sushila Digamber Naik & Ors. v. MHADA & Ors., 2010
Vol. 112(2) Bom. L.R. 639]

In the year 2003 majority of members of the
respondent-society including petitioners issued consent letters in support of
redevelopment of the society. The society applied to MHADA for its NOC. MHADA
also issued NOC for redevelopment. The authority issued order for temporary
eviction of tenements for redevelopment, wherein petitioners who had earlier
given consent withdrew the same and challenged the eviction order by the
respondent-authority.

The Court observed that in any redevelopment scheme where the
co-operative housing society/developer appointed by the co-operative housing
society has obtained no objection certificate from the MHADA/Mumbai Board,
thereby sanctioning additional balance FSI with a consent of 70% of its members
and where such NOC holder has made provision for alternative accommodation in
the proposed building (including transit accommodation), then it shall be
obligatory for all the occupiers/members to participate in the redevelopment
scheme and vacate the existing tenements for the purpose of redevelopment. In
case of failure to vacate the existing tenements, the provisions of S. 95A of
the MHADA Act mutatis mutandis shall apply for the purpose of getting the
tenements vacated from the non-co-operative members.

Thus as per the amended provisions of DCR 33(5), the
respondent-authority are empowered to invoke the provisions of S. 95A of the
MHADA Act and the petitioners are not correct in their submission that the
respondent-authority had no jurisdiction to pass the impugned order u/s.95A of
the MHADA Act. The petition was dismissed.

levitra

Nirav Shah

Nomination under an insurance policy only indicates hand which is authorised to receive the insured amount — Insurance Act, 1938.

New Page 1

[Anita Dilip Gaidhane and Anr. v. Bajirao Madhavrao
Gaidhane and Ors., 2010 Vol. 112(3) Bom. L.R. 1065]

The respondent No. 1 — father was nominated by the deceased
Dilip while effecting the insurance policies. The appellant i.e., wife and
daughter of the deceased Dilip applied for succession certificate. The Trial
Court refused to grant succession certificate to the appellants on the ground
that the respondent No. 1 — father was nominated by deceased while effecting
insurance policies. The appellants contention was that admittedly they were
class-I heirs, therefore entitled to one-third share in the money payable under
various policies, which could be declared by the Court instead of undergoing
another round of litigation.

The Court held that the amount assured shall be paid to the
nominee in order to give discharge to the insurer, but it does not mean that the
nominee becomes the owner of the amount and that S. 39 cannot operate as a third
kind of succession and the nominee cannot be treated equivalent to an heir or
legatee. At the same time, it also held that the nomination only indicates the
hand which is authorised to receive the amount, on the payment of which the
insurer gets a valid discharge of its liability under the policy. The amount,
however can be claimed by the heirs of the assured in accordance with the law of
succession governing them.

The Court further held that even after remarriage to another
person in a different family, a widow, having acquired absolute interest in the property of her deceased husband, is
not divested of the same. To avoid multiplicity of litigation, the Court
directed the insurance company to release the amount payable under the policies
to the father and on receipt of the amount payable under the policies, the
father shall distribute the same to the appellants in equal proportion.

levitra

Nirav Shah

Mens rea and penalty u/s.271(1)(c) of the Income-tax Act, 1961

Case Study

Case Study No. 1

1.0 Facts of the case :

1.1 Mr. Shivdasani, the assessee, filed his return of
income for A.Y.2006-07 declaring an income of Rs.5,00,000. Mr. Shivdasani
claimed a deduction u/s.35 in respect of a contribution of Rs.1,00,000 to an
institution approved for the purpose of S.35. The institution has issued a
receipt in acknowledgement of the contribution. The receipt bore the approval
number.

1.2 In the course of assessment, it is found that the
institution to which the contribution was made was not approved for the
purpose of S.35. The institution had forged the approval. The A.O. disallows
the claim and initiates proceedings for imposing penalty under S.271(1)(c) for
furnishing inaccurate particulars of income.

1.3 Mr. Shivdasani replies to the show-cause notice issued
for imposing penalty. One of the contentions of Mr. Shivdasani is that he
genuinely believed that the institution was approved for the purpose of S.35,
and that the claim was not mala fide.

1.4 The A.O. nevertheless imposes penalty on the ground
that the issue whether there was a bona fide belief or that the
intention was not mala fide in making a claim for a deduction, was
irrelevant particularly after the Honourable Supreme Court’s decision in the
case of UoI vs. Dharmendra Textiles Processors, 306 ITR 277. According
to the A.O. it is sufficient for imposing penalty that there results evasion
of tax on account of a claim made in the return which claim is found untenable
on assessment. The A.O. also highlights the fact that the assessee has
accepted the disallowance by not preferring an appeal against the assessment
order.

1.5 The assessee prefers an appeal against the penalty
order. Your views are solicited on the submissions to be made to the CIT(A) in
connection with the appeal filed against the penalty order.

2.0 Submissions :

2.1 It is true that it is irrelevant in penalty proceedings
under civil law whether there was guilty mind (mens rea) or not. In
other words, it is not necessary to prove presence of mens rea in
penalties imposable under civil law, more so after the decision of the SC in
the case of Dharmendra Textiles Processors (supra). However, this
decision should not be applied in a blanket manner to all penalty matters
under the Income-tax Act, for the reasons, one, that the SC decision does not
directly deal with a penalty imposable under S.271(1)(c), and two, the
decision does not make S.273 B otiose. That is, an assessee can always explain
the circumstances which led him to believe that his claim for a deduction was
made bona fide. S.273 B requires an A.O. to consider the reply
furnished by the assessee under S.273B, and it is only after the A.O. has come
to the conclusion that there was no reasonable cause for the assessee to make
the claim under S.35 that the A.O. can impose penalty. In this case, the
appellant did have a receipt issued by the donee institution indicating that
it was an approved institution under S.35, giving no reason to the assessee to
suspect its genuineness. Thus, the appellant had reason to believe that his
claim was legitimate.

2.2 The case of the appellant is also not governable by
Explanation 1 to S.271(1) to say that the assessee is deemed to have
concealed the particulars of his income. The Explanation is reproduced here :

Explanation 1 — Where in respect of any facts
material to the computation of the total income of any person under this
Act, —

(A) such person fails to offer an explanation or offers
an explanation which is found by the Assessing Officer or the Commissioner
(Appeals) or the Commissioner to be false, or

(B) such person offers an explanation which he is not
able to substantiate and fails to prove that such explanation is bona
fide and that all the facts relating to the same and material to the
computation of his total income have been disclosed by him,

then, the amount added or disallowed in computing the
total income of such person as a result thereof shall, for the purposes of
clause (c) of this sub-section, be deemed to represent the income in respect
of which particulars have been concealed.

2.3 One can see that this is not a case where the appellant
fails to offer an explanation. It is also not a case where the explanation as
offered by the appellant is found to be false. It must be remembered that what
is found to be false in this case is the ‘receipt’ issued by the donee
institution, not the explanation of the appellant. Therefore clause (A) of
Explanation 1 does not apply.

The appellant has shown that his explanation is made
bona fide which he is substantiating with the receipt issued by the
institution. It is also not a case where all the facts relating to the claim
and material to the computation of income have not been disclosed. Therefore,
clause (B) of Explanation 1 will also not apply. The A.O., therefore, cannot
hold any income in respect of which particulars have been, or deemed to have
been, concealed.

2.5 In view of the above submissions, the penalty as
imposed may be deleted.

Case Study No. 2

1.0 Facts of the case :

1.1 Mr. Haridasani was a resident of Dubai for a number of years. Later, he moved to India and started business.

1.2 For F.Y.2005-06, relevant to A.Y.2006-07, Mr. Haridasani had acquired the status of Resident and Ordinarily Resident. Since the business operations of Mr. Haridasani were low and since Mr. Haridasani had only the income from investments held abroad, he had not engaged services of any professional to assist him in preparation of his return of income.

1.3 Mr. Haridasani declared only his Indian income in the return for A.Y.2006-07. He filed his full personal accounts with the return of income showing all his investments in India and abroad and also filed full extracts of bank accounts showing credit in respect of all income including income earned abroad. He had filed his earlier returns similarly in respect of the preceding years. The case for A.Y. 2006-07 was for the first time selected for scrutiny under 5.143. The A.O., on finding his income abroad, brought it to tax and imposed penalty for concealment of income. Mr. Haridasani had pleaded innocence and lack of familiarity with the Indian laws since he had stayed abroad for a number of years and also for the fact that he had not engaged any professional to advise him. His pleas were turned down and penalty for concealment of income was imposed. The A.a. also mentioned in”his penalty order that innocence, or lack of mens rea, was no longer available as a defence since the promulgation of the SC decision in the case of UoI. vs. Dharmendra Textiles Processors, 306 ITR 277. Mr. Haridasani had preferred an appeal against the order imposing penalty and seeks your advice in preparing arguments to be made before CIT(A).

2.0 Submissions:

2.1 The penalty in this case is imposed for the act of ‘concealment of income’ as opposed to the act of ‘furnishing inaccurate particulars of income’. The two acts, namely, of ‘concealment of income’ and of ‘furnishing inaccurate particulars of income’ are two different circumstances both leading to penalty under S.271(1)(c) — Please refer to eIT vs. Indian Metal & Ferro Alloys Ltd., 117 CTR (Ori) 378, which succinctly draws distinction between the two circumstances and explains what they mean. The following passage from the said decision is self explanatory.

“The expressions ‘has concealed the particulars of income’ and ‘has furnished inaccurate particulars of income’ have not been defined either in Section 271(1)(c) or elsewhere in the Act. One thing is certain that these two circumstances are not identical in details although they may lead to the same effect, namely, keeping off a certain portion of income. The former is direct and the latter may be indirect in its execution. The word ‘conceal’ is derived from the Latin word ‘concolare’ which implies ‘to hide’. Webster’s New International Dictionary equates its meaning to ‘hide or withdraw from observation; to cover or keep from sight; to prevent the discovery of; to withhold knowledge of’. The offence of concealment is thus a direct attempt to hide an item of income or a portion thereof from the knowledge of the Income-tax authorities. In furnishing its return of income, an assessee is required to furnish particulars and accounts on which such returned income has been arrived at. These may be particulars as per its books of account if it has maintained them, or any other basis upon which it has arrived at the returned figure of income. Any inaccuracymade in such books of account or otherwise which results in keeping off or hiding a portion of its income is punishable as furnishing inaccurate particulars of its income.”

2.2 Once the position is admitted that the circumstance leading to penalty is ‘concealment of income’, one must proceed to find out the applicability of the ratio of the SC decision in the case of UoI. vs. Dharmendra Textiles Processors, 306 ITR 277.

2.3 It is true that the said decision does lay down the principle that the presence of mens rea need not be proved in civil matters before imposing penalty unlike in criminal matters. However, the said principle comes with a caveat. The caveat is that mens rea need not be proved only if the language of a provision imposing penalty does not require the presence of mens rea to be proved. In other words, if the language requires that a penalty cannot be imposed unless the assessee had a guilty mind before committing the act leading to the penalty, then the presence or absence of a guilty mind assumes importance. As per the decision in the case of Dharmendra Textiles Processors what is of paramount importance is the language of the provisions imposing penalty. The Honourable SC has also relied on the language of S.276C providing for prosecution in cases where a person wilfully attempts to evade tax, to make the point since this provision requires the element of mens rea to be proved before the person can be prosecuted because the language of the provision clearly requires so, the person cannot be prosecuted unless he had a guilty mind. Moreover, while deciding the case of Dharmendra Textiles Processors, the SC has approvingly quoted from its earlier decision in the case of Gujarat Travancore Agency vs. CIT, 177 ITR 455. According to the said decision which was rendered in the context of S.271(1)(a) of the Act, the SC confirmed penalty imposed under S.271(1)(a)where the appellant had no malafide in filing his return late because the Court did not find anything in the language of S.271(1)(a) which required the presence of mens rea to be established before a penalty could be imposed. Thus, what is important is not whether the presence of mens rea is essential or not before imposing penalty in civil matters, but the language of the particular provision under which the penalty is sought to be imposed.

2.4 With the above back ground let us see whether the language of S.271(1)(c) requires the presence of mens rea when the penalty is sought to be imposed on the ground that the assessee has concealed the particulars of his income.

2.5 The words used in these provisions are ‘the assessee has concealed … ‘. As per the standard dictionary the word ‘conceal’ in ordinary English means, ‘I. to hide; withdraw or remove from observation; cover or keep from sight: e.g., He concealed the gun under his coat. 2. to keep secret; to prevent or avoid disclosing or divulging: e.g., to conceal one’s identity by using a false name. In this regard, please also refer to the decision in CIT vs. Indian Metal & Ferro Alloys Ltd., 117 CTR (Ori.) 378 and particularly to the passage reproduced in paragraph 2.1 above which explains the meaning of the word ‘conceal’.

2.6 One may appreciate that the idea of deliberateness is implicit in the word ‘conceal’. Concealment is not accidental or involuntary, it is planned and voluntary. The following observations of the Honourable SC made in the case of T. Ashok Pai vs. CIT, 292 ITR 11 still hold good:

“concealment of income’ and ‘furnishing of inaccura te particulars’ carry different connotations. Concealment refers to a deliberate act on the part of the assessee. A mere omission or negligence would not constitute a deliberate act of suppressio veri or suggestio falsi”.

2.6 Therefore, it is submitted that if the charge on the assessee is of concealing particulars of his income, the assessee can rebut the charge by proving lack of mens rea. This construction of the provision is not inconsistent with the ratio of the Honourable SC’s decision in the case of Dharmendra Textiles Processors (supra) for the reason that the said decision also lays stress on the language of particular provision imposing penalty. The decision merely forbids the presumption of requirement of proving mens rea; it does not say that one should ignore such requirement if it is demanded by the very provision imposing penalty.

2.7 In view of the submissions and the facts of the case, penalty should be deleted.

Author’s Note:
The stand taken in these case studies seems to be vindicated by the recent decision of the Supreme Court in the case of Uol vs. Rajasthan Spinning & Weaving Mills – Civil Appeal No. 2523 of 2009, where the Supreme Court has explained its decision in Dharmendra Textile Processor’s case.

Nirav Shah

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